Month: April 2017

Compliance Bricks and Mortar for April 28

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

District Court Rules Plaintiff Failed To Plead Real Estate Investment Was A “Security” by Keith Paul Bishop in California Corporate & Securities Law

In ruling on the defendants’ motion, Judge Benitez correctly observed that the plaintiff’s securities law claims require that there be a “security”.  He then analyzed the plaintiff’s allegations in light of the U.S. Supreme Court’s definition of an “investment contract” in SEC v. Howey, 328 U.S. 293, 66 S. Ct. 1100, 90 L. Ed. 1244 (1946) (“whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others”).  Applying Howey, Judge Benitez ruled that the plaintiffs had failed to allege adequately the existence of a security [More…]

Sessions Dodges, Weaves, Promises on FCPA by Matt Kelly in Radical Compliance

Then again, Sessions also danced around the question of whether zealous U.S. enforcement of anti-corruption laws puts U.S. companies at a competitive disadvantage on the global stage. At one point in his speech, he praised anti-corruption enforcement as a vehicle to reward the many good companies out there that don’t bribe their way to success. [More...]

An app that pinpoints white-collar criminals works like predictive-policing software by Jack Smith IV, Mic

A new app and website called White Collar Crime Risk Zones , which goes by the initials WCCRZ, shows exactly what neighborhoods are chock full of financial criminals, how much damage they’re doing and even what they might look like.

Using data from the Financial Industry Regulatory Authority, a team of technologists affiliated with the left-wing magazine  New Inquiry created the open-source tool so that anyone can put a face on the labyrinthian world of white collar crime hidden in their own home town. [More…]

Yates Memo – Time for Reassessment? by Sharon Oded in NYU Law’s Compliance & Enforcement

While other U.S. authorities have recognized individual accountability as an important enforcement goal, the DOJ’s policy as promulgated by the Yates Memo demonstrates a more rigorous approach. In contrast to the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC), which consider a company’s disclosure of individuals’ involvement in the misconduct as an important factor in their analysis,[[iii]] the Yates Memo has adopted an “all-or-nothing” approach: it requires corporations to disclose to the DOJ all relevant facts about individuals’ involvement in the misconduct in order to qualify for any cooperation credit. Accordingly, regardless of whether the company has voluntarily reported the misconduct and fully cooperated with the investigation—e.g., by sharing relevant information, facts, analyses and internal investigation reports, making employees available for interviews and facilitating their representation, or taking state-of-the art remediation action to prevent reoccurrence—it cannot benefit from any credit unless it has ‘sacrificed’ the involved employees. [More…]

Does your team botch the NFL draft? Find out here: How every team’s draft picks since 1996 lived up to expectations. by Reuben Fischer-Baum in the Washington Post

By comparing how much value teams should get given their set of picks with how much value they actually get, we can calculate which franchises make the most of their draft selections. Approximate Value (AV), a stat created by Pro Football Reference that measures how well a player performed overall in a season, is useful here. Based on this metric, we find that the Browns draftees have underperformed in the NFL given their draft position, especially when compared to the draftees of a team like, say, the Seahawks .[more…]

The One With The Options Pricing Theft

Some financial fraud is easy to spot. Some is hard to spot. Some I barely understand. Kevin Amell was very clever in hiding his alleged fraud and I’m not sure I understand exactly how he pulled it off.

Mr. Amell was a fund manager at Eaton Vance for its Risk-Managed Diversified Equity Income Fund. The fund used options to hedge some of its positions and Mr. Amell had some responsibility for the purchase or sale of call options. According to the complaint, on at least 265 occasions, Mr. Amell pre-arranged the purchase or sale of call options between the Fund’s brokerage accounts and his personal brokerage account at prices that were disadvantageous to the Fund and advantageous to Amell. He generated almost $2 million in profits for himself.

Mr. Amell carried out the fraud by placing orders in his personal brokerage accounts to buy specific options at a specific price and at the same time placed orders on behalf of the funds to sell the same options at the same price. He took advantage of the trades with wider spreads and exploited the spread. The fund order was just outside the midpoint of the spread so the market would not take the trade. He took the trade in his personal account and then sold for the difference in the market.

It seems like one of those frauds where the scammer just takes a little bit each time.

One thing hanging out there for me, from a compliance perspective, is how did he get caught.

He did not report the account to Eaton Vance and did not tell the brokerage that he was an employee of Eaton Vance. That means it would be hard for the firm to find the fraud. He clearly violated the firm’s policies.

In paragraph 28 of the complaint, the SEC notes that the initial brokerage account he used for the fraud was closed by the brokerage. I assume the broker’s compliance noted something was fishy. Mr. Amell opened an account at a different broker-dealer and resumed the fraud for another year. Perhaps that second brokerage noted the weird trades and decided to report it to the regulators instead of just closing the account.

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Financial Choice Act 2.0 for Private Fund Managers

The Republican agenda is moving ahead to unwind much of the Obama Administration’s legislative and regulatory achievements. The first attempt to repeal the Affordable Care Act failed. Next up is raising the debt ceiling, tax reform and Dodd-Frank appeal. (I question how much Congress can take on at one time.)

Jeb Hensarling, Chairman of the House Financial Services Committee, had a law he was ready to move forward with and now has a second version in a discussion draft. There are good things in the Financial CHOICE Act of 2017.

General solicitation

It narrows the meaning of general solicitation. Section 452 provides that a presentation at the following is not an act of general solicitation:

  1. College or University
  2. Non-profit
  3. Angel investor group
  4. Venture forum, or
  5. trade association

provided the advertising for the event does not reference a securities offering, and the event sponsor does provide investment advice to attendees, does not charge a fee other than for administrative costs, and the issuer limits the information provided.

Clearly, this is trying to get the regulatory regime in  line with industry practice for venture capital. Issuers don’t want to be engaged in general solicitation, but the definition is too narrow.

Venture exchange

The bill contemplates the creation of marketplace for buyers and sellers of venture securities. The issuer would not have gone through an IPO. It must have a market cap of at less than $1 billion. It seems strange to use the definition of a market cap, when there is no existing market for the securities.

Regulation D and Form D

The bill slams the door on the SEC’s proposed changes to Form D. Those changes have been sitting on the SEC’s agenda for over two years.

Accredited Investor

Section 860 of the bill changes the definition of “Accredited Investor.” It keeps the two current brightline tests of income and net worth. I think those are key tests given the illiquid nature of private placements. It fixes those standards and removes Dodd-Frank’s requirement that the SEC adjust the amounts every four years.

The bill adds in a third test, allowing anyone licensed as a broker or investment adviser to also be an “accredited investor.” It adds a fourth test, allowing the SEC to create a regulatory regime for individuals to prove that the knowledge, education or job experience to allow them to invest in private placements.

We have seen from SEC Acting Commissioner Piwowar that he on board with opening up the definition of accredited investor.

Private equity fund exemption

The bigger change for private equity funds and probably for real estate funds is that it exempts “private equity fund” managers from the registration and reporting obligations of the Investment Advisors Act.

As you might expect, the bill does not take the time to define “private equity fund.” It gives the SEC six months to issue a rule for the definition.

The arguments are that private equity should be treated like venture capital. Private equity does not pose systemic risk. Private equity investors are generally sophisticated. The SEC would be more effective focusing its exam efforts on retail investment advisers.

What next?

Obviously this bill is a long way from being enacted. Chairman Hensarling is working on the pitch and has come up with the Top 10 wins for American People with the Financial Choice Act.

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Weekend Reading: Evicted

Matthew Desmond took a deep dive into poverty and housing. He published the story of what he saw in Evicted: Poverty and Profit in the American City. The book follows several people in deep poverty living and being evicted from terrible housing in Milwaukee. Mr. Desmond lived among them in 2008 and 2009. He split his time between the poor, white College Mobile Home Park full of the white poor on one side of town and a rooming house on the poor black side of town.

The housing problems did not appear to discriminate based on race. However, Mr. Desmond found that the vast majority of evictions were against black women. Regardless, the problem was a lack of money. Most of the subjects were scrapping by without any meaningful work or on public assistance. That assistance paid for the rent, but left little remaining after rent. They pay a crushing share of their income for rent. The book’s subjects were paying 75%+ of their income for rent. That left little for food, health care, clothing, furniture, and transportation.

Part of book’s story is that evictions are much more common than previously thought. More than one in eight Milwaukee renters faced a forced move in the course of three years. A forced move includes a larger selection of reasons beyond formal evictions, including strong arm tactics, building condemnation, and paying unwanted tenants to leave. In Milwaukee, 16 families lose their homes each day: 16,000 people being forced out of 6,000 housing units every year.

Mr. Desmond also included the two landlords in the book. They were doing better financially than their tenants, but they were not fat cats rolling in cash. There is money to be made from renting to the poor. But it also means an uneven flow of cash when rent goes unpaid, properties are damaged, and the court fees for getting an eviction. The biggest financial windfall for the landlord was when one of the buildings caught on fire. She pocketed the insurance money and bulldozed the charred remains.

The landlord are overlooking the convictions and evictions to rent to tenants that would be excluded from other mainstream housing. In exchange, the tenants overlook the poor housing conditions.

There are no easy answers in the book. In the epilogue, Mr Desmond offers some direction. It requires money. More government assistance for the poor to get housing.

The book is compelling. While not necessarily enjoyable to read, it is well written and easy to digest, as distasteful as it may be. The book has won many awards, including the Pulitzer Prize.

Publishers occasionally send me books in exchange for a review. That was the case the here.

Happy Patriots’ Day

And the shot heard ’round the world
Was the start of the Revolution.
The Minute Men were ready, on the move.
Take your powder, and take your gun.
Report to General Washington.

– Schoolhouse Rock!

Patriots’ Day is a celebration of the anniversary of the Battles of Lexington and Concord, the first battles of the Revolutionary War. (With the success of the New England Patriots over the last 15 years, some may confuse this holiday as a celebration of football.) The battle recreations on the field in Lexington Green are very different than the battles on the field at Gillette Stadium.

Patriots’ Day is a celebration of Paul Revere and William Dawes.  They mounted their horses and spread the warning: “The British are coming!” (You don’t know about Hawes because Longfellow didn’t write a poem about him.) Those rides started out with the “one if by land, two if by sea” signal from the Old North Church.

Patriots’ Day is a celebration of the Boston Marathon. Runners start their 26.2 mile journey in Hopkinton, up Heartbreak Hill by my house and into Copley Square

Patriots’ Day is a celebration of baseball, with an early Red Sox home game ending in time for baseball fans to turn into marathon fans as the runners pass near Fenway Park.

Patriots’ Day  is a celebration of being out of the office. It’s a Massachusetts holiday. Since Maine was once part of Massachusetts, it’s also a holiday in Maine. (Although Maine switches the possessive to Patriot’s Day.)

So I’m out of the office today and for the rest of the week on vacation.

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Broker Dealer Private Fund

It was four years ago that David Blass mentioned that the SEC was taking a closer look at broker-dealer requirements for private fund managers in two contexts: selling interests in the funds and earning fees from the fund for capital transactions.

Part of the problem is that the safe-harbors for selling your fund interests is much narrower than people expect:

  • the person limits the offering and selling of the issuer’s securities only to broker-dealers and other specified types of financial institutions; or
  • the person performs substantial duties for the issuer other than in connection with transactions in securities, was not a broker-dealer or an associated person of a broker-dealer within the preceding 12 months, and does not participate in selling an offering of securities for any issuer more than once every 12 months; or
  • the person limits activities to delivering written communication by means that do not involve oral solicitation by the associated person of a potential purchaser.

Mr. Blass indicated that the SEC might consider granting a new exemption for private funds. (Of course that is a new regulation and presumably, the SEC would want to revoke two other regulations before making a new one.)

A recent case before the SEC touched on this area. Gregory Smith provided insurance and retirement planning services. At one point he was a registered representative associated with a broker dealer, but was not when he started selling interests in Rampart Fund. Rampart was a private fund selling notes to fund a mezzanine debt program.

Mr. Smith sold $3.75 million worth of notes to 31 investors and received transaction based compensation.  His activities were outside of any of the three safe harbors.

The SEC barred him from the securities industry, and required disgorgement of the compensation for failing to register as a broker-dealer while selling private fund interests.

Of course this case feels different than in-house personnel selling private fund interests. I’m not sure the exemptions treat it differently. I believe many firms look to the “perform substantial duties for the issuer other than in connection with transactions in securities” safe harbor. For dedicated sales personnel, that argument may fall flat.

I suspect what put Mr. Smith in the cross-hairs of the SEC is that Rampart turned out to be a fraud. Mr. Smith raised almost half of the capital that ended up going to Rampart.

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Slapping Down Investment Research Website

The Securities and Exchange Commission took the “extreme step” of warning consumers that articles on the internet may not be objective and independent. They sent up a warning signal to deceptive promoters by announcing enforcement actions against 27 individuals and entities behind various alleged stock promotion schemes that left investors with the impression they were reading independent, unbiased analyses on investing websites while writers were being secretly compensated for touting company stocks.

From the cases, it  looks like the SEC found a rat’s nest of stock promotion companies, wiling to say great things about public companies in exchange for a fee. In total the SEC filed fraud charges against three public companies, seven stock promotion or communications firms, two company CEOs, six individuals at the firms, and nine writers.

In one case, the person engaged in the business of providing stock promotion services to publicly-traded issuers, and directed the publication on investment websites of over 400 articles about its issuer clients and the clients of an affiliated promotional services company.

“Despite being paid for their work, the writers failed to disclose their compensation in the articles and therefore misrepresented the nature of their relationship with the clients to the investing public.”

This included violating the terms on some major investment websites like SeekingAlpha and Motley Fool. Each of these require a disclaimer that the writer had not received compensation for an article.

The charges are all for fraud, deception or omitting material facts in violation of several securities laws.

The cases don’t address the line between lawfully promoting a company as part of public relations and fluff pieces that the SEC is concerned about here. It appears that the writers and scheme purposefully tried to look like impartial investors promoting their favorite stocks and doing so in places that expect impartial articles.

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The Overbooking Failure

Air travel has gotten has gotten less pleasant over the years. The TSA makes it unpleasant to get to the plane. Then the plane themselves have reduced passenger room. United took the unpleasantness to an even lower level when it forcibly removed a passenger from an overbooked flight.

“Flight 3411 from Chicago to Louisville was overbooked,” the spokesperson said. “After our team looked for volunteers, one customer refused to leave the aircraft voluntarily and law enforcement was asked to come to the gate.

“We apologize for the overbook situation. Further details on the removed customer should be directed to authorities.”

According to a passenger report:

Passengers were told at the gate that the flight was overbooked and United, offering $400 and a hotel stay, was looking for one volunteer to take another flight to Louisville at 3 p.m. Monday. Passengers were allowed to board the flight, Bridges said, and once the flight was filled those on the plane were told that four people needed to give up their seats to stand-by United employees that needed to be in Louisville on Monday for a flight. Passengers were told that the flight would not take off until the United crew had seats, Bridges said, and the offer was increased to $800, but no one volunteered.

Then, she said, a manager came aboard the plane and said a computer would select four people to be taken off the flight. One couple was selected first and left the airplane, she said, before the man in the video was confronted.

Overbooking happens. We are all used to hearing the announcements and the request for volunteers. That’s a weakness in the system. The airlines allow no-show passengers.

The failure in this instance appears to be of United’s own making since the space was needed for United’s own flight personnel.

Then it stepping into absurdity and brutality by viciously pulling a paying customer from his seat and dragging him down the airplane aisle in front of other passengers. Put the blame on both the security personnel and flight personnel for handing a situation in the worst way possible.

What should have been done differently? With a small snippet, it’s hard to tell. There are many things we don’t know from a single passenger statement and a blurry video. Obviously it should never have come to that point.

United should not have allowed passengers to board the plane. That was the proper checkpoint.

It’s hard to tell what the impact will be on United for the poor handling of this situation. I’m sure it will make some potential customers chose other airlines.

For me, it’s just another reminder of how unpleasant airline travel is. We’re driving on our next vacation to avoid this unpleasantness. I would not want a member of my family to be subjected to this treatment, nor would I want them to witness something like this.

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Compliance Bricks and Mortar for April 7

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

You Need to Know This: YTD Securities Class Action Lawsuit Filings are Off the Charts by Kevin LaCroix in the D&O Diary

Securities class action lawsuit filings have been going crazy. Securities suit filings during the first quarter 2017 set a pace that if continued would mean an unprecedented number of securities lawsuit by year end. But even more significant than the sheer number of lawsuits is the rate of litigation. The percentage of listed companies sued in the first quarter, if annualized, would mean that U.S. public companies are being sued at four times the long-term historical rate. As discussed below, three factors account for much of the upsurge in securities suit filings. [More…]

Denials and Admissions in Civil Enforcement – Looking Beyond the SEC by Verity Winship and Jennifer K. Robbennolt in NYU’s Compliance & Enforcement blog

Should agencies require admissions of guilt from the targets of civil enforcement? The SEC’s policy of letting enforcement targets settle while neither admitting nor denying allegations provoked judicial rebukes and a public debate. But the SEC is only the tip of the iceberg. Administrative agencies rely heavily on settlement as a key enforcement tool. Admissions of guilt—or, more commonly, declarations that nothing is admitted—form part of these settlement agreements and the underlying negotiations. [More…]

The Easiest Way to Help Save the Planet: Get a Bike

From eradicating health concerns linked to inactivity, to mitigating climate change, to boosting local economies and building community, biking… is an integral part of the solution. It just has some image and infrastructure issues to overcome. [More…]

The One About The Defrauding Pastor

When you run across someone trying to get you to invest risk-free with a high annual return, you know you have run into a fraudster. Unless god is on the side of the investment, there is no such thing as a high-rate, risk-free return.

Apparently, Larry Holley, the pastor of Abundant Life Ministries in Flint, Mich., thought he could cloak his securities in god’s will and pass them off to parishioners.

According to the SEC complaint, Holley and his associate Patricia Enright Gray, used faith-based rhetoric, with references to scripture and biblical figures to pitch fraudulent promissory notes from a real estate company. From February 2015 until recently, approximately 83 individuals invested with pair.

Holley labeled his church as a “place of provision” and “distributors of knowledge, wisdom, wealth & substance.” To be fair to the pastor, it looks he and the church had spent time buying and fixing up homes for those in need. It just seems he crossed the line at some point.

Holley allegedly told prospective investors that as a person who “prayed for your children,” he was more trustworthy than a “banker” with their money. He held financial presentations masked as “Blessed Life Conferences” at churches. As part of the presentation he asked congregants to fill out cards with information on their finances and he promised to pray over the cards.

Apparently, he turned over the financial information to Gray for the hustle and she would have a on-on-one meeting to help them become millionaires. During the consultations, Gray showed prospective investors a large book filled with photographs of what she represented to be some of real estate company’s properties, testimonials from satisfied investors and copies of checks paid to investors.

The real estate company, Treasure Enterprise, did exist and did own some real estate. The company did not invest the money fast enough or profitably enough to meet the payments on the promissory notes. Perhaps the goal was legitimate at first. (I don’t know.) When Treasure missed its investment marks, Holley and Gray could have broken the news to investors. Instead, it looks like they increased their fundraising efforts to cover the shortfall. (Which of course just increases the shortfall.) The pair used payments of the fresh capital to payoff earlier investors in exchange for dropping their complaints to regulators.

As of February 2017, Treasure was past due on approximately 51 promissory notes for 43 investors, totaling nearly $2 million.

The State of Michigan had caught up with them before the SEC. The Michigan Department of Licensing and Regulatory Affairs used a cease and desist order in August for selling unregistered securities, from acting as unregistered agents and from making false or misleading statements in the offer and sale of securities. Unlike the SEC, Michigan can put them in jail.

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