Month: September 2010

We Have Video of Barney Frank Arguing With a Dining Room Table

After pushing through the Dodd-Frank Wall Street Reform and Consumer Protection Act, Barney Frank now needs to run for re-election. He is not running unopposed in the Democrat primary, but the opposition is … “interesting.”

Barney is the congressman for my district, so I have voted for him in the past and plan to vote for him again. I would have hard time voting or his primary opponent. He will also have to face a Republican candidate in November, either former Marine Sean Bielat or businessman Earl Sholley.

Last year at a town hall meeting, a woman named Rachel Brown, a Lyndon LaRouche follower who accuses President Obama of acting like Adolph Hitler, challenged Financial Services Committee Chairman Barney Frank with a question. He responded that talking to Ms. Brown “would be like trying to argue with a dining room table.” The Congressman does not usually argue with furniture.

Unfortunately, Brown was so incensed that she decided to run against him for his Congressional seat. For some unknown reason, Frank actually agreed to a televised debate with her.

She decided to compare Obama to Roman Emperor Nero instead of Hitler at the beginning of the debate. She also thinks we should be piping water in from Canada to invigorate the American economy.

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Ethics Upgrade at Oracle?

I’m not sure what to make of Mark Hurd, Hewlett-Packard, Larry Ellison, and Oracle.

HP threw Hurd out on the street for some stupid behavior. By throwing out on the street, I mean let him keep most of his compensation package.

Larry Ellison immediately came to his defense. He even went a step further and hired him as co-president of Oracle. Not only that, they are giving him a seat on their Board of Directors.

That angered H-P so much they filed a lawsuit to stop him from taking the job. They want him on the street, not with a competitor.

I keep scratching my head over the behavior of H-P’s board. They fired him, but let him keep a compensation package. If they thought it was a serious ethical lapse, then they should have made it for cause and kept the compensation. The definition of “for cause” was probably set too high for Hurd’s stupid actions. But the H-P Board didn’t even try.

Oracle’s stock jumped on the news of Hurd’s hiring. H-P’s Stock took a tumble when they announced his firing.

It makes a compliance and ethics guy like me scratch his head and wonder: does compliance and ethics really matter? To answer that, we need to look at the original incident and decide if Hurd’s behavior so unethical that he should have been fired.

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Credit Rating Agency Investigated for Fraud

The SEC brought an action against LACE Financial for issues with its independence. We also learned that the SEC had investigated whether rating agency Moody’s Investors Service, Inc. violated the registration provisions or the antifraud provisions of the federal securities laws.

Moody’s was working on a rating for some new European securities. They ended up giving the security an Aaa rating. They later discovered a problem with their model and found a coding error. After finding the error, a Moody’s rating committee met and discussed the problem.

They made no change to the outstanding credit rating. The SEC found smoking gun emails that showed rating committee members were concerned about the impact on Moody’s reputation if it revealed an error in the rating model.

“In this particular case we seem to face an important reputation risk issue. To be fully honest this latter issue is so important that I would feel inclined at this stage to minimize ratings impact and accept unstressed parameters that are within possible ranges rather than even allow for the possibility of a hint that the model has a bug.”

That does not sound like the company was living up to the principle of the Rating Agency Act to “improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating agency industry.”

The SEC declined to bring an enforcement action “of uncertainty regarding a jurisdictional nexus to the United States in this matter.” The rating committee responsible for the credit ratings of the rated securities met in France and the United Kingdom. The rated securities were arranged by European banks and marketed in Europe.

The Commission notes that, in recently enacted legislation, Congress has provided expressly that federal district courts have jurisdiction over Commission enforcement actions alleging violations of the antifraud provisions of the Securities Act of 1933 or the Exchange Act involving “conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors” or “conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” Dodd-Frank Wall Street Reform and Consumer Protection (Dodd-Frank) Act, Pub. L. No 111-203, § 929P(b)(1), (2) (2010) (to be codified at 15 U.S.C. §§ 77v(c), 78aa(b)). NRSROs should expect that the Commission, where appropriate, will pursue antifraud enforcement actions, including pursuant to such jurisdiction.

It sure sounds like the SEC is looking hard at rating agencies and their culpability for the Great Panic of 2008.

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Credit Rating Agencies and Conflicts of Interest

Personally, I place a big chunk of blame on the Credit Rating Agencies for the Great Panic of 2008. They were throwing AAA ratings at piles of garbage. There is an inherent conflict in the rater being paid by the security issuer instead of the security purchaser. They are beholden to the customer and the customer wants a great rating for its security.

Exchange Act Rule 17g-5(c)(1) prohibits a Nationally Recognized Statistical Rating Agency from issuing or maintaining a credit rating solicited by a person that, in the most recently ended fiscal year, provided the NRSRO with net revenue equaling or exceeding 10 percent of the total net revenue of the NRSRO for the fiscal year.

“The Commission’s rules were designed to further the goals of the Rating Agency Act to “improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating agency industry.” To meet these goals, it is critical that firms provide accurate information to the Commission and the public in their Form NRSROs and financial reports, that they do not have prohibited conflicts, and that they establish, maintain, and enforce policies and procedures to address conflicts of interest.”

LACE Financial submitted an application to register as an NRSRO on October 31, 2007. LACE also requested an exemption from the 10 percent rule, which the SEC granted. LACE requested the exemption because LACE’s largest client (“Firm A”) provided LACE with more than ten percent of LACE’s total revenue during fiscal year 2007. Firm A managed Collateralized Debt Obligation (“CDO”) and hired LACE to prepare regular reports that Firm A distributed to investors in these CDOs.

According to the SEC Release, in an attempt to keep the 2007 revenue from Firm A as close as possible to ten percent of its total revenues for the year, LACE postponed billing Firm A for reports completed during December 2007 until January 2008. In its exemption request letter, LACE stated that its estimated annual revenues from Firm A for 2007 would be $119,000 when calculated on a cash basis and $179,000 when calculated on an accrual basis. “The total value of work performed for Firm A by LACE during 2007 was in fact $233,268.28, approximately 28 percent of LACE’s revenues for the year when properly calculated on an accrual basis as required by GAAP.”

LACE got slapped with a civil money penalty in the amount of $20,000 and an injunction not to break the law again. They also charged Damyon Mouzon, the president of LACE, blaming him for trying to shift revenue and deliberately hide the conflict of interest.

It seems clear to me that the rating agencies were not trying to protect investors. They were trying to generate revenue. That means keeping their clients, the securities issuers happy.

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Compliance Bits and Pieces for September 3

You are either getting your kids back to school, enjoying a vacation, or enjoying everyone else being out of the office on vacation.

Me? I’m out of the office.

There was still some interesting compliance news this past week:

SEC employees win battle to dress casual By Zachary Goldfarb for Market Cop

Some of the Securities and Exchange Commission’s rank-and-file employees have won a quiet battle with top officials: They no longer have to wear formal business attire when out on the job.

Trust Me – I’m from HR/ IT/ Legal/ Finance ! by Charles H. Green in Trust Matters

These internal staff have exactly the same challenge that their outside brethren have—to successfully persuade and influence others, over whom they have exactly zero direct authority. But it’s worse for internals: first, because they eat in the same lunchroom as their clients and are known by their first names, they tend to not get the same respect that outside experts do.

The Impact of Dodd-Frank – And a Warning to Rating Agencies by Thomas O. Gorman in SEC Actions

The Moody’s Investors Services, Inc. Section 21(a) report released on August 31, 2010 gives an indication of the potential impact of Dodd-Frank. It is based on an existing limitation of the enforcement program, but reflects the removal of that impediment by the legislation. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: Moody’s Investors Services, Inc., Exchange Act Release No. 62802 (Aug. 31, 2010).

Image is Lone Tree. Footpath from Tealby Thorpe to Willingham Woods. The tree is a relic of a lost hedgerow.
By Kate Nicol

FCPA Release 10-03: Foreign Agents as Foreign Officials

The Department of Justice released its latest FCPA Opinion Release. The requesting company for this opinion release is stepping into a situation full of FCPA red flags. In the end, the DOJ opined that it would not bring an enforcement action based on the safeguards put in place by the company.

The company is involved in “natural resource infrastructure development” and trying to get a government contract. They want to hire a consultant who has previously and currently holds contracts to represent the foreign government
and act on its behalf and a registered agent of a foreign government pursuant to the Foreign Agents Registration Act, 22 U.S.C. § 611 et seq. Of course, the consultant is being paid on a contingency basis.

The DOJ points out that the FCPA does not “per se prohibit business relationships with, or payments to, foreign officials.” They look for these factors in the business relationship:

  • indicia of corrupt intent
  • transparency to the foreign government and the general public
  • whether the arrangement is in conformity with local law
  • whether there are safeguards to prevent the foreign official from improperly using his or her position

In this case, the company is putting extensive safeguards in place. The DOJ found the safeguards were good enough.

The consultant is an agent of the foreign government and there are situations in which the consultant will act on behalf of the foreign government, so the company should treat the consultant and its employees “foreign officials” for purposes of the FCPA.

The company is walling off the employees working on the various representations from each other and is disclosing  the relationships to the relevant parties. The business relationships are permitted under local law. The obligations limit representation of the foreign government by the consultant are sufficient to ensure that the consultant will not be acting on behalf of the foreign government in acting for the company.

The walling off and limitations are actually enough to pull the consultant out from under the label of being a “foreign official.”

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Blatant Self-Promotion

Each year, LexisNexis “honors a select group of blogs that set the online standard for a given industry.” This year, they expanded Top Blogs to include their Business Law Communities.

Compliance Building is one of the nominated candidates for the LexisNexis Top 25 Business Law Blogs of 2010, featured on the LexisNexis Corporate & Securities Law Community and the LexisNexis UCC, Commercial Contracts & Business Law Community.

Looking at the list of candidates, I see many blogs that I read regularly. If you are looking for a list of business law blogs to read, the list of nominees is a great place to start.

I think most of the nominated blogs are much better than mine. Whether its on quality, popularity, or some other factors, there is no way I will make it into the top 25. I will sit back and take the consolation prize: the honor of being nominated.

Lexis Nexis invites you to comment on the announcement post at either of the following links:

Top 25 Business Law Blogs 2010 – Corporate & Securities Law Community

Top 25 Business Law Blogs 2010 – UCC, Commercial Contracts & Business Law Community

To comment, you have to register. Registration is free and supposedly does not result in sales contacts. The comment period for nominations ends on October 8, 2010. They don’t say how they will end up selecting the top 25 out of the nominees other based on their review and your comments.

I’m also not sure how the Lexis-Nexis Communities fits in with the Martindale Hubbell Connected platform. There seems to be whole lot so substantive information in Communities that is missing in Connected. They should get these two sites together.

Vote for the business law blogs you feel are the best. Include Compliance Building if you think it’s worthy.

Telling the Truth During Earnings Calls

Is the CEO or CFO lying during the quarterly earnings call? How can you tell?

David F. Larcker and Anastasia A. Zakolyukina of the Stanford Graduate School of Business turned to the rich data set of quarterly calls and subsequent financial restatements. After studying Q&A sections of transcripts of hundreds of calls with CEOs and CFOs, the researchers then looked to see whether financial statements being discussed were substantially restated at some point after the call. If they were restated, Professor Larcker and Zakolyukina (a PhD student at the school)  reasoned that the executive had been “less than candid.”

They found that answers from deceptive executives:

  • have more references to general knowledge
  • fewer non-extreme positive emotions
  • fewer references to shareholders value and value creation
  • use signi significantly fewer self-references, more third person plural and impersonal pronouns
  • more extreme positive emotions
  • fewer extreme negative emotions
  • fewer certainty and hesitation words

Their performance is only 4% to 6% better than a random guess. So it’s statistically significant, but not determinative.

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