FINRA Is Thinking About Changing Its Communications Rules

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Financial Industry Regulatory Authority (FINRA) posted a regulatory notice  on proposed new rules governing member communications with the public: Regulatory Notice 09-55.pdf-icon

The new rules would replace current NASD Rules 2210 and 2211, the Interpretive Materials that follow NASD Rule 2210, and portions of Incorporated NYSE Rule 472.

The proposal would replace the existing six categories of communication with three new communications categories and revises certain approval, filing and content requirements. These changes make the rules easier, but seem to make it harder for FINRA members to participate in social media. I am surprised that FINRA did not try to squarely address the use of the popular internet and web 2.0 tools.

Communications Categories

Currently NASD Rule 2210 divides communication into six separate categories:

  1. advertisement
  2. sales literature
  3. correspondence
  4. institutional sales material
  5. independently prepared reprint
  6. public appearance.

The principal approval, filing and content standards apply differently to each category.

FINRA is proposing to consolidate those six categories into the following three:

  1. institutional communication, which would include communications that fall under the current definition of “institutional sales material,”
  2. retail communication, which would include any written communication that is distributed or made available to more than 25 retail investors
  3. correspondence, which would include any written (including electronic) communication that is distributed or made available to 25 or fewer retail investors

Communications that currently qualify as advertisements and sales literature generally would fall in the proposed retail communication.

Approval Requirements

The proposed rule changes would require an appropriately qualified registered principal of the firm to approve each retail communication before the earlier of its use or filing with FINRA.

Filing Requirements for New Firms.

FINRA rules currently require a firm that has previously not filed advertisements with FINRA to file its initial advertisement with FINRA at least 10 business days prior to use, and continue the practice for one year after the initial filing. The proposed rule would require filing of all retail communications  (the new category), rather than just advertisements. The proposal would have the one-year filing requirement beginning on the effective date a firm becomes registered with FINRA, rather than on the date an advertisement is first filed with FINRA.

Pre-Use Filing Requirement.

The proposal would expand the current pre-use filing requirements so that communications concerning any registered investment company that includes self-created rankings, and retail communications that include bond mutual fund volatility ratings would have to be filed with FINRA at least 10 business days prior to first use and withheld from use until changes specified by FINRA staff have been made. The proposal would expand the filing requirements for materials relating to closed-end investment companies to include retail communications distributed after the fund’s initial public offering.

Press Releases

The proposal eliminates a current filing exclusion for press releases that are made available only to members of the media. Most firms post press releases on their Web sites, making them available to the general public.

Content Standards

The Proposal reorganizes, but largely incorporates, the current content standards applicable to communications with the public. Content standards that currently apply to advertisements and sales literature generally would apply to retail communications.

Public Appearances

Public appearances would have to meet the general “fair and balanced” standards and the standards applicable to recommendations
if the public appearance included a recommendation of a security. If you recommend securities in public appearances generally you would be subject to the same disclosure requirements under proposed FINRA Rule 2210(f) as research analysts that recommend securities in public appearances pursuant to NASD Rule 2711(h). The proposal requires firms to establish appropriate written policies and procedures to supervise public appearances, andmakes clear that scripts, slides, handouts or other written and electronicmaterials used in connection with public appearances are considered communications with the public for purposes of proposed FINRA Rule 2210.

The comment period for the proposed rules ends November 20.

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The CFO’s and CCO’s Role in Fundraising

PERE Real Estate CFOs Forum

Yesterday, I attended the PERE Real Estate CFOs Forum. These are my notes from this session:

  • Moderator: Steve Felix, Head of Client Relations-Real Estate, Aviva Investors
  • Ira Bergstein, Principal & CFO, Palisades Financial, LLC
  • Jack Foster, Head of Real Estate, Franklin Templeton Real Estate Advisors
  • Asha Richards, Vice President & General Counsel for the Private Equity Funds Group, Brookfield Asset Management Inc.

What is the compliance officer’s role in fund-raising?

Number one is creating a system and process for creating consistent marketing materials and messages to investors. Process and consistency are key. You need to push on the distribution team to be consistent.

What’s changed in fund-raising?

There is a lot of focus on track records and how the firms have dealt with the issues over the last 12 months. There is an increased focus on real estate and investors are paying closer attention to the real estate investments. Part of this is the personal nature of real estate. People inevitably compare their house and the residential real estate markets to the commercial real estate markets.

What’s changed about what investors and potential investors are looking for?

Investors are looking for information to be delivered faster. Investors are looking for projections of distributions, even if they are speculative. Investors are looking for more standardization in the reports.

Managing Private Real Estate Funds – The Changing Role of the CFO and Chief Compliance Officer

PERE Real Estate CFOs Forum

Yesterday, I attended the PERE Real Estate CFOs Forum. These are my notes from this session.

  • Moderator: Gary Koster, Americas Leader- Real Estate Fund Services, Ernst & Young LLP
  • Peter C. Cluff, Principal, Europa Capital LLP
  • Stuart Koenig, Global CFO & Chief Administrative Officer, AREA Property Partners
  • Dominic Petrucci, Chief Financial Officer, Buchanan Street Partners

What are the most demanding issues confronting the CFO role? The panel came up with these:

  • Investor relations
  • Compliance
  • Valuations
  • Liquidity management
  • Debt refinancing

Investor relations is not a new concept, but investors are looking closer at their investments in real estate. Investors want transparency from their investments. There is a need to be proactive instead of reactive and increase disclosure. Investors are being reactive to the financial crisis news. So there were requests for amount of Lehman exposure, Madoff exposure and custody procedures that came out of last year’s crises.

Regulatory compliance is looming in front of the industry. Some of this was a reaction to hedge funds, but the regulatory proposals do not define “hedge funds” and end up putting real estate funds in the splash zone. There is lots of uncertainty on how the regulations are going to affect the business model for private equity real estate funds.

Valuations are an issue because there is so little trading of properties. Tenant rental rates are also greatly in flux. There is increased use of third party appraisals above and beyond the requirements in the fund agreements. The most recent property sales varied widely and offered little help in determining values.

There is some concern that interests are getting out of alignment with more assets getting underwater. Firms need to be aware of the potential conflicts and deal with it head-on. It’s important to emphasize that the general partner sponsors also have money invested and is as much at risk as the investors. The concern is that you might lose good people who are looking for more entrepreneurial opportunities, leaving behind a more asset management focused model. It’s important to keep younger people in the organization because of the valuable lessons they have learned about the commercial real estate market in a downturn.

Debt: The Missing Link

PERE Real Estate CFOs Forum

Yesterday, I attended the PERE Real Estate CFOs Forum. These are my notes from this keynote session by Schecky Schechner, Managing Director, US Head of Real Estate Investment Banking, Barclays Capital.

There is a wave (a wall?) of real estate debt maturities coming due over the next three years.

He started talking about the private markets. There are banks and insurance companies lending to commercial real estate. Lenders are making debt offers are becoming more reasonable. There is less availability over $100 million. Since the valuation of commercial real estate is difficult giving the lack of transactions, lenders are looking more to debt yield. They are basing the amount of the loan on cash flow.

There has been some REMIC relief [See New Rules Ease the Restructuring of CMBS Loans] so that securitized lenders can alter the terms of the loans when there is reasonable likelihood of default. But servicers are somewhat overwhelmed. There are increasing numbers of loans going to special servicing.

TALF is now eligible for CMBS. But there is almost no activity. No deals have priced. There are some questioning whether commercial real estate debt presents a systemic risk

The unsecured debt markets have come back. But this is mostly limited to the public REITs. The credit spread for REIT debt is narrowing form 491bps over 10 Treasury notes earlier this summer to 275bps today.

Mortgage REITs are coming to life. Since June there have been 12 blind pool mortgage REITs filed with the SEC that were looking to raise $5 billion. The cover a spectrum of different business plans. There are some people thinking that the blind pool model may not work. Some think you need to have a partially identified pool of assets. There are also some concerns over the incentive fees put into place. The window seems to be closed right now. The mortgage REITs are using leverage. They are getting REPO facilities and credit lines based on a borrowing base.

The Mezzanine market has lots of money sitting on the sidelines looking for opportunities. But opportunities are scarce.
Subscription lines are scarce. But they are out there. The terms are shorter. There is some concerns that limited partners may be defaulted on their capital calls.

What are the implications for private equity real estate funds?

One is the pretend and extend approach. Lenders and investors are hoping to get through it, with time healing the problems.
Another option is TALF. But access seems limited.

The last and most interesting is the public option. The buy side of the market is looking for internally managed with a focused market approach. You may be able to recapitalize with public equity. The volatility of the public equity market has declined. Mutual fund flows have turned positive. Risk appetite has increased. Public company implied cap rates are trading tighter than their private counterparts.

There is also increased activity in “Make-a-REIT” filings. Sponsors are looking to expand their current portfolio and bulking up the portfolio in connection with the public offering.

Shifting Regulatory Landscape in the US and Abroad

PERE Real Estate CFOs Forum

This afternoon, I am speaking at the PERE Real Estate CFOs Forum in New York on the Shifting Regulatory Landscape in the US and Abroad.

Moderator: Gilbert D. Porter, Partner, Haynes & Boone LLP
Panel Members:
Andrea Carpenter, Director, INREV (European Association for Investors in Non-listed Real Estate Vehicles)
Doug Cornelius, Chief Compliance Officer, Beacon Capital Partners
R. Eric Emrich, Chief Financial Officer, Lubert Adler Partners, L.P

We are starting the discussion with the EU AIFM Directive and its potential implication on fundraising and operations in the European Union.  Then we move onto the four bills aimed at regulating private funds: the Hedge Fund Adviser Registration Act of 2009, the Hedge Fund Transparency Act of 2009 and the Private Fund Transparency Act of 2009 and the . Then we end with the SEC’s proposed Pay to Play rule and the Say on Pay bill.

I am leading the Pay to Play and Say on Pay discussions. Here is the slide deck that I am using:

Governing Corporate Compliance and New Governance

Miriam-Baer

Miriam Baer of the Brooklyn Law School published an interesting article on “New Governance”: Governing Corporate Compliance. The professor rejects the notion that adversarial relationships produce good regulation. She looks towards the “theory of regulation characterized by a collaborative tone between regulator and regulated entity, a problem-solving orientation, continuous assessment and revision of both expected outcomes and implementation processes, pooling of information by and among regulated entities and regulators, and inter-agency cooperation.”

She views compliance programs as “instrumentalities of hard law: formal regimes designed to supply internal monitoring and punishment, so that the firm can then assist the government in fulfilling its duties of external monitoring and punishment.” Of course you are not going to get a cooperative method of regulation when the primary response to corporate wrongdoing is the prosecution and punishment of individuals. Executives put compliance programs in place because it is good business. They also implemented them because they don’t want to go to jail. Executives are increasingly being punished for the bad acts of their frontline employees.

The professor advocates a model in which “regulators and regulated entities would treat compliance problems—even large scale violations of criminal law—as a symptom of a continuing problem to be addressed over time, rather than as a cultural failure that could be “cured” by some combination of prosecutorial threat and internal ethics remediation.”

Thanks to Ellen S. Podgor of the White Collar Crime Prof Blog for pointing out the article: .

References:

Pfizer and Compliance

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Pfizer got itself in trouble for the way it was marketing some of its drugs. Enough trouble that they need to cough up a $2.3 billion fine to the Department of Justice. (Yes, that is billion.) Under its settlement with the DOJ, Pfizer will pay a $1.3 billion criminal fine related to the company’s illegal promotion of its now-withdrawn painkiller, Bextra, and $1 billion civil fine related to other medicines. It’s the largest health-care fraud settlement in the DOJ’s history.

But that’s not all.

As part of the settlement, Pfizer entered into a Corporate Integrity Agreement with the Office of Inspector General of the U.S. Department of Health and Human Services. The Corporate Integrity Agreement establishes some new internal structures and requires Pfizer to continue maintenance of a corporate compliance program for a period of five years.

Pfizer already had a compliance program, headed by a chief compliance officer, which trains employees on how to properly promote Pfizer’s products. The big change is that the chief compliance officer will no longer report to the general counsel, but will report directly to the CEO. The change is intended to eliminate conflicts of interest and prevent Pfizer’s in-house lawyers from reviewing or editing reports required by the Corporate Integrity Agreement.

If you wonder whether the compliance program should report to the general counsel, the Department of Justice says they should not.

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The SEC’s Madoff Report

madoff

The SEC decided to take a look at how it failed to uncover the Madoff fraud. The SEC’s Inspector General has been running an investigation and compiling information. The SEC Inspector General, H. David Kotz, released a public version of their report on August 31: Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme – Public Versionpdf-icon

The big question being whether it was case of internal corruption or just incompetence. Of course, hindsight is 20/20 and the fraud looks so obvious, you have to wonder how they missed it. I think it is more important to learn from the mistakes so they can avoid this happening again. But people are still looking for heads to put in the guillotine.

Senate hearing

Of course, politicians are looking to blame someone. Today at 2:30, the Senate Banking Committee will hold a  hearing concerning Oversight of the SEC’s Failure to Identify the Bernard L. Madoff Ponzi Scheme and How to Improve SEC Performance. The witnesses currently slated are:

  • H. David Kotz, Esq., Inspector General of the U.S. Securities and Exchange Commission;
  • Mr. Harry Markopolos, Chartered Financial Analyst and Certified Fraud Examiner;
  • John Walsh, Esq. Acting Director, Office of Compliance Inspections and Examinations, SEC
  • Robert Khuzami, Esq., Director of the Division of Enforcement, SEC

Was there corruption?

The investigation did not find evidence that any SEC personnel who worked on an SEC examination or investigation of Madoff had any financial or other inappropriate connection that influenced the conduct of their examination or investigatory work. The report also concludes that former SEC Assistant Director Eric Swanson’s romantic relationship with Bernard Madoff’s niece, Shana Madoff, did not influence the conduct of the SEC examinations of Madoff. The report concludes that no senior officials at the SEC directly attempted to influence examinations or investigations of Madoff and that there was no evidence of interference with the staff’s ability to perform its work.

How much did the SEC know?

The Inspector General found that the SEC received more than ample information over the years to warrant a comprehensive investigation of Madoff. Despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. Between June 1992 and December 2008 when Madoff confessed, the SEC received six substantive complaints that raised significant red flags concerning Madoff’s operations. There was enough for SEC to question whether Madoff was actually engaged in trading.

What about private investors?

I found it unusual that the Inspector General includes information from private parties about their due diligence findings of Madoff’s operations. Many sophisticated investors gave significant money to Madoff. But there were traders, funds, investment banks, and other investors who thought something was not right with Madoff. They were concerned about the suspiciously consistent returns, the lack of transparency, the use of a small captive auditing firm, and the lack of an independent custodian.

The decisions to not invest were made based upon the same red flags that the SEC considered in its investigations, but ultimately dismissed. The Inspector General concludes:

The SEC examination program should analyze the approaches utilized by private entities who conducted due diligence of Madoff’s operations and apply these methods to strengthen their program. They should also seek to learn from these private entities through training mechanisms and in fact, several private entities informed the OIG that they would be willing to conduct training of SEC examiners in their due diligence approaches. Learning from private sector efforts would improve the SEC’s ability to conduct meaningful and comprehensive examinations and detect potential fraud.

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Respondeat Superior and Compliance

oil tanker

Back in January, a company was found criminally liable for the action of its employees. (Second Circuit Affirms Ionia Management Case.) Under respondeat superior (Latin for “let the master answer”) a company can be held vicariously liable for crimes committed by employees acting within the scope of their employment.

Ionia operates and manages shipping vessels which transport oil to the United States. These ships produce oil-contaminated bilge waste, which they have to store for proper disposal. The Act to Prevent Pollution from Ships, makes it a crime to knowingly dispose of this waste improperly.

Ionia’s engine room crew, under the direction and participation of the Chief Engineers and Second Engineer, routinely discharged oily waste water into the high seas through a “magic hose” designed to bypass the vessel’s Oily Water Separator, which would have cleaned the waste to prepare it for disposal as required by law. Furthermore, the Kriton’s crew made false entries in the ORB to conceal such discharges, and obstructed a federal investigation (a) by hiding the “magic hose” from Coast Guard inspectors during a March 20, 2007, inspection and (b) by lying to Coast Guard officials.

There was some hope that the court would alter the doctrine of respondeat superior and include a good faith defense or limit the doctrine to higher level employees. A company can be brought down by lower level employees violating company policies.

In One Rogue Worker Can Take an Entire Company Down Stanley A. Twardy Jr. and Daniel E. Wenner wrote that “the trial court charged the jury that a corporate defendant could be held criminally responsible for the conduct of a single low-level employee, even if that employee acted in direct contravention of corporate policy and a robust compliance program.”

I didn’t read the case as taking that position and I still don’t.

First, there was a structural problem in the appeal. Ionia did not challenge the jury instruction at trial, so the Second Circuit was limited to a review for plain error.

Second, Ionia took the position that corporate criminal liability can “can only stem from the actions of so-called ‘managerial’ employees.” That contention seems at odds with United States v. Twentieth Century Fox Film Corp., 882 F.2d 656, 660 (2d Cir.1989) In the Second Circuit, “[i]t is settled law that a corporation may be held criminally responsible for [criminal] violations committed by its employees or agents acting within the scope of their authority.” United States v. Twentieth Century Fox Film Corp., 882 F.2d 656, 660 (2d Cir. 1989). Regardless, evidence show that the Chief Engineers specifically directed the deck hands to commit the criminal acts.

Third, the prosecution does not need to prove as a separate element that the corporation lacked effective policies and procedures to deter and detect criminal actions by its employees. “A corporate compliance program may be relevant to whether an employee was acting in the scope of his employment, but it is not a separate element.” The mere existence of contrary company policies is not by itself a defense to criminal liability. Whether a company has an official position on the course of conduct undertaken by its agents is merely one factor to be considered when assessing whether to impose vicarious liability.

I think this case show the importance of a compliance program. Merely having policies in place in not enough to defend the company from criminal liability. Policies alone are not enough to cause employee behavior to conform to policy. Compliance programs need training, procedures and enforcement to be effective.

I am sure it was Ionia’s policy to not dump the untreated bilge water in violation of the law.  They just were not doing enough to prevent it.

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Fired for Foiling a Bank Robbery

key

Jim Nicholson was working at a Key Bank branch when a man entered the bank and demanded money. Rather than comply with the robber’s demands, Nicholson tossed his bag to the floor, lunged at the suspect and demanded to see a weapon. The man ran, and Nicholson chased him for several blocks before knocking him down with help from a passerby. Nicholson then held the suspect, Aaron J. Sloan, 29, until police arrived.

Two days later he was fired for violating company policy.

Is this the wrong result?

“Our policies and procedures are in the best interests of public safety and are consistent with industry standards. Money, which is insured, can be replaced. Lives cannot.” – Key Bank spokeswoman Anne Foster

“It really doesn’t matter if you’re a bank teller or a citizen walking down the street. Generally speaking, it’s best to be a good witness. And quite honestly, this is also true for people who are off-duty police officers too.” – Seattle Police Sgt. Sean Whitcomb

The policy clearly makes sense. There is no need for a bank employee to confront and chase a bank robber. Discipline was clearly the response.

The firing does send message to the rest of the KeyBank employees. Don’t do something stupid like confronting a bank robber. Focus on good identification so the police can find the robber. Let the police do their job.

What would have happened if the robber injured or killed Nicholson during the struggle? What is Nicholson injured or killed the robber?

Would a warning or suspension have been a better disciplinary action? Since the bank would presumably covered by insurance, there would have been no loss to the bank. So Nicholson endangered himself for no benefit to the bank. Any action that would encourage others would be reckless and endanger lives.

I think KeyBank did the right thing. But perhaps someone could help him find a new job.

What do you think?

Thanks to some Twitter followers for their thoughts:

  • @ComplianceWeek: I’d dock pay and make him employee of the month. Fired for bravery seems wrong.
  • @JennSteele: Something about the outright firing just sits wrong with me. Maybe it’s my American bent towards vigilantism
  • @Jeffrey_Brandt: Give him a reward before firing him
  • @BillWinterberg: Non-compliant bank teller could have turned out much worse. Bank policies exist for very good reasons.
  • @EthicsArbitrage: That’d be a real problem if carried out consistently. We’d run out of employees. Non-compliance=fired.
  • @DrewCollier: admire his bravery, admonish his disregard to policy. it’s a poor example to others and could get someone killed next time.

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