Month: January 2012

Informants and Insider Trading

The cooperation of a single Wall Street trader has led directly led to the prosecution of 10 individuals. That makes David Slaine one of the most productive informants in the history of US financial crimes.

In a sentencing memorandum (.pdf), the US Attorney’s office states that “Slaine’s cooperation has been nothing short of extraordinary” and “truly exceptional”. It lays out the series of of prominent insider trading cases that came from his information: Rajaratnam, Goffer, Kimelman, Drimal and others.

This all came from Slaine’s actions back in 2002. According to the information filed by the prosecutors, Slaine starting getting tips from a UBS analyst. The analyst was leaking information in whether UBS was going to change its securities recommendations. Slaine was then trading ahead of the upgrades and downgrades.

To reduce his sentence, Slaine agreed to help prosecutors and helped unravel a huge ring of traders using inside information. One of the startling aspects of the cases was the widespread use of wiretaps. This was a technique not often seen in insider trading cases.

1:09-cr-01222-RJS USA v. Slaine in the Southern District of NY

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Compliance Bits and Pieces for January 13th

Here are some compliance-related stories for Friday the 13th:

Regulatory Risk Factors in the Carlyle Group S-1 by Seattle lawyer William Carleton.

The Carlyle Group is preparing to go public. There are some interesting risk factors in the S-1 registration statement relating to use of leverage in investments, continued control of prior owners following the offering, and other topics. But I was drawn to the risk factors having to do with the regulatory environment. It’s a different angle from which to think about the financial crisis, financial regualtory reform, and the scourge of lobbying and campaign contributions.

Lawyers v. Businessmen: Where Are the Bad Men?

In the glamorous/murky/elite/financially rewarding world of commercial law is it clients or lawyers who are the bad guys?  Put another way, does business corrupt law or do lawyers corrupt business?  This is the question that lies at the heart of Parker, Rosen and Nielsen’s paper.   Since the Savings and Loan scandals via WorldCom, Enron and latterly UK’s ownHackgate, corporate wrongdoing is often accompanied by the question, Where were the lawyers?  And as Big Law turns increasingly, well, ‘big’, the “is law a business or a profession” question is posed increasingly nostalgically, usually with deliberate exaggeration and answered only with speculation rather than evidence.  It is refreshing, therefore, to report on a study which is deals with the relationship between law and business empirically and with imagination which also deals with conceptually important questions.

Manufacturing Jobs, Robots, and the Economy

We still make lots of stuff in the United States. China is our closest competitor. The two countries are very close at the number 1 and number 2 positions of manufacturing output.  In the past decade, manufacturing output in the US has risen by a third. What hasn’t risen is the number of jobs in manufacturing. In the last ten years, those have decreased by a third. About 6 million jobs disappeared.

Adam Davidson of NPR traveled to South Carolina to get a better picture of what has happened. In Greenville, he found shuttered textile plants but found lots of hi-tech factories.

The double shock we’re experiencing now—globalization and computer-aided industrial productivity—happens to have the opposite impact: income inequality is growing, as the rewards for being skilled grow and the opportunities for unskilled Americans diminish.

Its going to get worse for unskilled workers. A factory owner puts it bluntly. He is willing to invest in a machine that will earn back its cost in two years. If a robot can do your job, hope that it costs at least twice your salary.

This all leads back to thinking about the Great Recession that come from the 2008 financial crisis and comparing it to the Great Depression. One theory is that the Great Depression stemmed from the movement from agricultural jobs to manufacturing jobs. It’s starting to look like the Great Recession stemmed from the movement away from manufacturing jobs. We were using residential real estate as a piggy bank to help through the transition, but we eventually broke the piggy bank.

The latest numbers from the end of 2011 show some solid signs of job growth and consumer borrowing is on the rise. it seems clear from Davidson’s story that some of the jobs will never come back. It’s more important than ever to invest in education and training.

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Image of a closed factory is by Rubbertoe

The Rise and Fall of Jon Corzine

Bryan Burrough, William D. Cohan and Bethany McLean have a piece in this month’s Vanity Fair on Jon Corzine, the man behind the spectacular crash of MF Global. It doesn’t provide much insight into what happened at MF Global or where the missing money went. But is does paint an interesting picture of the captain of the ship.

Unlike a nautical captain who drowns when his ship sinks, Corzine may escape. According the article, he had only a small percentage of his wealth in the firm. His wealth did not vaporize. The lawyers and class action suits against Corzine will likely take a big chunk of his remaining wealth. His career as a trader and money manager are likely over.

In piecing together earlier episodes in his career, one stuck out at me from a compliance and risk perspective. While a young trader at Goldman Sachs, Corzine was involved in a screwed up trade that was mishandled and exceeded the firm’s risk limits. In the end, the trade ended up making money, but that won no accolades. The trade violated compliance and risk policies and was non grata. We generally only hear about rogue traders when they lose money. At the time, at least according to the article, Goldman took a dim view on rogue traders who made money.

The other item that emerged is the Corzine was self-made. He is certainly part of the 1% now, but didn’t start out that way. One thing that has bothered me about the Occupy Wall Street movement is a somewhat misguided rage against the 1%. When looking at the income discrepancies over the last twenty years, I think people miss the fact that the people in the 1% are not all the same people that were int he 1% twenty years ago.

Unlike aristocracy, you do not need to be born into the 1% to become part of the 1%. (Sure, it usually helps to start off well-to-do.) It seems to me that combining lots of hard work, lots of education, and little bit of good luck can get you an entrance ticket to the 1%.

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Is a Mitt Romney Candidacy Good for Private Equity?

Mitt Romney puts his business background at the front of his campaign message. As the current front-runner for the Republican nomination, his background is going under increased scrutiny. Since his business background is in private equity, the industry should stop and wonder whether all of this publicity will be good or bad for private equity.

Hopefully people will not be as confused by private equity as they are with whether “Mitt” is short for Mittens. In listening to hearings on private equity and venture capital, many congressmen seem to think that private equity is only about leveraging healthy companies with lots of debt, firing lots of the employees, then quickly ripping them apart, and selling the pieces. If successful. Otherwise, they fire most of the employees and merely plunge their portfolio companies them into bankruptcy.

There is the obvious problem in how you define success. The Wall Street Journal looked at the Bain portfolio and found that 22% of its portfolio companies either filed for bankruptcy or shut down. The story failed to add any context about whether that is better or worse than average. Lots of companies run into trouble. There were over 13,000 Chapter 11 bankruptcy filings in fiscal year 2010. Add in some percentage of the 1.5 million chapter 7 bankruptcies that were businesses, not individuals.

Certainly, Bain Capital made money for its investors. The Wall Street Journal found that Bain produced about $2.5 billion in gains for its investors who had put in $1.1 billion in capital.

Even in the Walk Street Journal story, there is a disagreement about the right measuring stick and which failures should be attributed to Bain. In some cases, the failure came after a partial Bain exit.

Of course, the statistics can’t cover what would have happened to the business if Bain failed to step in or private equity failed to take an interest. They may have failed anyway.

I suspect the answer to whether private equity is good or bad will be twisted around Mitt Romney. His supporters will laud his business success and his detractors will attack his job cuts and business failures. (I lived with Mitt Romney as governor and don’t have a position on candidacy. He was mostly limited by the state legislature in what he could do, a similar position that Congress limits Presidential action. )

In the end, private equity will likely come out of the election cycle bruised and battered.

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US Private Equity Fund Compliance Companion

If you are looking for a good guide to help your private equity compliance program, PEI Media’s US Private Equity Fund Compliance Guide is a good place to start. There have been a few changes since its publication in 2010. PEI Media has just published the US Private Equity Fund Compliance Companion to provide an update on the new and amended regulations, hoping to deliver some timely information before the March 30, 2012 registration deadline.

Charles Lerner of Fiduciary Compliance Associates was the lead editor and asked me to contribute a chapter. (That means I can offer you a discount of 20%. use the code: COMP_20)

Other contributors include:

  • Daniel Bender
  • Erik A. Bergman
  • Timothy M. Clark
  • Winston Chan
  • Peter Cogan
  • Doug Cornelius
  • Karl Ehsam
  • Kimberly Everitt
  • Daniel Faigus
  • Craig Friedman
  • Thomas S. Harman
  • David Harpest
  • Ebonie D. Hazle
  • Jeanette Lewis
  • Matthew Maulbeck
  • Leslie Meredith
  • Edward D. Nelson
  • John J. O’Brien
  • James T. Parkinson
  • Scott Pomfret
  • Michael Quilatan
  • Jay Regan
  • John Schneider
  • Justin J. Shigemi
  • Kate Simpson
  • Mark Trousdale
  • Joel A. Wattenbarger

PEI’s description.

 Featuring expert advice from over 30 compliance and legal professionals, this guide for chief compliance officers (CCOs) provides practical guidance on the legal and operational issues that registered investment advisers are required to comply with, and what the CCO role entails with useful checklists and practical tips.

The companion also features an exclusive roundtable discussion among a chief compliance officer, a head of investor relations and three attorneys. In this candid and informative session, these compliance experts discuss reporting net as well as gross performance results, limitation on general or public solicitations of investors, fundraising in new markets, limited partner due diligence and social media policy – it’s a discussion that will reveal the realities of the brave new world for registered investment advisers.

You can see the table of contents and read two chapters in the US PE Compliance Companion. (.pdf)

Compliance Bits and Pieces for January 6

These are some compliance-related stories that recently caught my attention:

Obeying the Law is Hard by Chris MacDonald in the Business Ethics Blog

For businesses, following the law doesn’t exhaust ethical responsibilities, but it’s an awfully good start. Most of us probably think that following the law is absolute minimally-decent behaviour for business. You absolutely must follow the law, and a business certainly shouldn’t be praised for achieving that basic minimum, right? But in fact, it’s not always so easy for companies to follow the law.

ERC’s National Business Ethics Survey

45 percent of U.S. employees observed a violation of the law or ethics standards at their places of employment. Reporting of this wrongdoing was at all-time high – 65 percent – but so too was retaliation against employees who blew the whistle: more than one in five employees who reported misconduct they saw experienced some form of retaliation in return.

Ten Compliance Issues from 2011 by Tom Fox

So as part of the compliance commentariati, I submit, for your consideration, my Top Ten anti-corruption and anti-bribery issues over the past 12 months.

  1. Amendments to the FCPA?…
  2. UK Bribery Act goes live…
  3. Crystal Ball Reading…
  4. Chief Compliance Officer Upgrade…
  5. Investigating Private Equity…
  6. ….

Conflict of Interest Risk Assessments – Part One by Jeff Kaplan in the Conflict of Interest Blog

Risk assessments are increasingly seen as essential to effective C&E programs. This is true for programs generally, of course, under the 2004 amendments to the Federal Sentencing Guidelines for Organizations. Risk assessments are also contemplated for anti-corruption compliance under the Good Practices Guidance of the OECD Anti-Bribery Working Group, the UK Bribery Act compliance guidance issued by the Ministry of Justice and settlements of various FCPA cases involving both compliance failures and model compliance programs.

Fraud Flashpoints: The Perils of Fake Social Media Profiles – A Growing GRC Concern – Part 1 by Daniel W. Draz in Corporate Compliance Insights

Everyone is talking about the use of social media applications in business, in fact it’s “all the rage!” While there’s no doubt it has incredible value and potential in a variety of business applications, something that most governance, risk and compliance (GRC) professionals don’t seem to be talking about is how the technology and usage of it applies in a corporate environment, where misinformation, competitive business intelligence, industrial espionage, “false profiles” and reliance on errant information, all generate the potential for significant business risk and liability.

In Depth On The Magyar Telekom and Deutsche Telekom Enforcement Action by the FCPA Professor

Total fines and penalties were approximately $95 million ($59.6 million against Magyar Telekom via a DOJ deferred prosecution agreement, $4.4 million against Deutsche Telekom via a DOJ non-prosecution agreement, and $31.2 million against Magyar Telekom via a settled SEC civil complaint). The SEC action against former Magyar executives remains active.

Handcuffs is from VectorPortal.com

Charges Brought in Social Media Scam

The Securities and Exchange Commission charged an Illinois-based investment adviser with offering to sell fictitious securities on LinkedIn. The SEC also issued two alerts to highlight the risks investors and advisory firms face when using social media.

The SEC’s Division of Enforcement alleges that Anthony Fields of Lyons, Illinois offered more than $500 billion in fictitious securities through various social media websites. In the complaint, they cite a LinkedIn posting to promote fictitious “bank guarantees” and “medium-term notes”:

“Bank Guarantees, Cash Backed, Deutsche Bank, Credit Suisse, HSBC, JP Morgan Chase, BNP Paribas, UBS, RBS or Barclays, One (1) year and one (a) day, Fresh Cut USD 500 Billion (USD 500,000,000,000) with Rolls and
Extensions 40% or better plus 1% commission fee to be paid, to buy side and sell side consultants 50/50. First Tranche: 500M USD . . . . If you are interested you can email for particulars . . . .”

The SEC pulled out a laundry list of violations. Fields was not registered as a broker-dealer nor listed as an associated person a registered broker-dealer at the time of the postings. He later set up an unfunded investment adviser and unfunded broker-dealer. Fields provided false and misleading information concerning assets under management, clients, and operational history to the public through its website and in SEC filings. Fields also failed to maintain required books and records, did not implement adequate compliance policies and procedures, and held himself out to be a broker-dealer while he was not registered with the SEC.

The question I have is did someone turn in Fields? Or is the SEC searching social media sites looking for suspicious securities postings?

In the new investor alert, the SEC offers tips to help avoid fraud online. (.pdf)

If you see a new post on your wall, a tweet mentioning you, a direct message, an e-mail, or any other unsolicited – meaning you didn’t ask for it and don’t know the sender – communication regarding a so-called investment opportunity, you should exercise extreme caution. An unsolicited sales pitch may be part of a fraudulent investment scheme.

The SEC points out the three big red flags:

  1. It sounds too good to be true
  2. A promise of guaranteed returns
  3. Pressure to buy right now

In addition to the investor-facing alert, the SEC also issued a risk alert aimed at a registered investment adviser’s use of social media. It once again points out that while the social media platforms may be new, the securities laws are not. You can only use the shiny new tools in compliance with the existing regulatory regime.

“While many RIAs are eager to leverage social media to market and communicate with existing clients, and to promote general visibility, RIAs should ensure that they are in compliance with all of the regulatory requirements and be aware of the risks associated with using various forms of social media. The staff hopes that sharing observations from its recent review of RIAs’ use of social media as well as its suggestions regarding factors that firms may wish to consider is helpful to firms in strengthening their compliance and risk management programs.”

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When Red Flags Are Not Enough

Purchase out of the money call options set to expire in two weeks, do not have any activity on that stock before, exclusively use options when you have rarely traded options in the account before, purchase those options just before the announcement of the company’s acquisition, and then quickly try to move the money off-shore.

Those red flags were enough for the Director of Compliance Operations at Interactive Brokers to put a hold on the account of Luis Martin Caro Sanchez. After reviewing the trades, the information was forwarded to the Securities and Exchange Commission for investigation. It reeked of insider trading, so the SEC obtained an immediate freeze on the account and charged Sanchez with insider trading.

Sanchez had bought several hundred of the risky Potash call options on August 12 and 13, 2010. A week later, the acquisition was announced causing a dramatic rise in the price of Potash stock. Sanchez managed to reap nearly $500,000 in profits at a handsome 1046% return. The actions seemed to be so blatant that I labeled it the perfect way to get caught insider trading. Of course one of the key elements of insider trading is having access to inside information.

Suspicious trades alone are not enough. In order for the SEC to win an insider trading case against a company outsider, the SEC must prove that an outsider made his trades based on material nonpublic information given to him by an insider. The SEC failed to find a connection.

Sanchez claimed he made became interested in Potash based on a technical signal “when he observed a crossover signal in the exponential moving average for the price of Potash stock.” He made the buy after

“there was a consolidation of the impulse of the cross of mediums, average, and that consolidation is known as pull-back, and consists of a slight drop in the price after a push for a higher price. And there was a hole that was filled – a gap that was produced during the increase – the previous increase.”

In fairness to Sanchez, he is from Spain and the interview was conducted without a certified, neutral translator. But to me, his explanation is just a bunch of mumbo-jumbo spewing out to make the SEC think he is a trading expert.

As much as the SEC tried, they could not link Sanchez to an insider. They could not even link him to his co-defendant, Juan Jose Fernandez Garcia. Both Garcia and Sanchez lived in Madrid and both made suspicious trades on Potash stock using accounts at Interactive Brokers. That was the only connection.

Garcia also happened to work at Banco Santander, who was an adviser to BHP in connection with its purchase of Potash. Garcia quickly settled with the SEC and forfeited his $576,032.00 in trading profits.

Sanchez was willing to fight for his windfall and challenged the SEC to prove he had inside knowledge. The SEC failed and Sanchez gets to keep his cash.

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Red Flags is Rutger van Waveren

The Great Depression versus the Great Recession

One of the signposts at the beginning of 2012 is that the U.S. economy seems to be recovering. The troubles in the Euro-zone are still creating great uncertainty and people are still cautious. But manufacturing outputs are continuing to increase. I see “help wanted” signs starting to appear in business doors. (Feel free to disagree with this conclusion.)

One sign of trouble is that the unemployment rate is still very high. There are 6.6 million fewer jobs in the United States than there were four years ago. Some 23 million Americans who would like to work full-time cannot get a job.

Those of you following the macro-economic responses to 2008s Great Recession know that Ben Bernanke was a student of the 1930s Great Depression. One of the lessons he took away was that the Federal Reserve’s tightening of the money supply as a response to the economic conditions  helped cause the Great Depression. Bernanke took the opposite response at the beginning of the Great Recession and opened the monetary spigots wide open as a response to the woes of the financial sector in 2008.

Bernanke saved the banking system, but the economy is still stubbornly not creating new jobs.

The failure to create jobs is unlike any other post-WWII recession. Look at the percentage of job losses in this chart.  It’s not just a dramatic loss in jobs. There seems to be structural loss in jobs that the economy is not creating. You can see it in the numbers of the long-term unemployed.

It looks like something has changed in our economy.

Joseph E. Stiglitz, a man much smarter than me, has made some comparisons between the Greet Recession and the Great Depression in the December issue of Vanity Fair: The Book of Jobs. His theory is that the dramatic upheavals in the economy are a result of dramatic changes in the workforce.

Just before the Great Depression more than 1/5th of all Americans worked on farms. By comparison,today only 2% of Americans produce our food, plus a surplus to ship to other countries and to burn as fuel in our cars. Accelerating productivity before the Great Depression created a surplus of farm products, which lead to lower prices, which lead to a decline in farm incomes. Farmers had borrowed heavily to sustain production and were faced with the inability to pay back the banks. This swept the financial sector into the “vortex of declining farm income.” The 1930s America was moving from an agricultural economy to a manufacturing economy.

The parallel to 2008 is that the US economy has realized a tremendous increase in productivity in manufacturing. Contrary to popular opinion, American still has a robust manufacturing base. American manufacturing output has doubled since 1975.

We just don’t make as much of the same stuff as we did in 1975. Labor intensive products are made cheaper overseas. You won’t see the Made in the USA label very often on clothing, toys, and consumer electronics. It takes one third fewer people to manufacture twice as much stuff in America. Bruce Greenwald and Judd Kahn theorize that although the loss of jobs to overseas providers is significant, it’s the increase in productivity that caused most off the job losses in the manufacturing sector.

Andrew McAfee and Erik Brynjolfsson point out that the human workforce has to compete against the automated workforce of computers and machines. If a computer can do your job, then your job may be in danger. This is becoming increasing true in white collar jobs and not just manufacturing.

Stiglitz theory is that the cheap debt and rising home prices of the last decade allowed us to disguise the loss in jobs an income that came from the loss in manufacturing jobs. As a county, we were using our homes as piggy banks creating artificial demand. In 2008, the curtain was pulled back to reveal the true weaknesses in parts of the economy.

Perhaps it’s time to compare the abandoned farms of the 1930s to the abandoned homes of today’s Detroit.

What does this mean for compliance?

I’m not sure. Certainly, it will mean more changes. I expect we will continue to see changes in regulations and business practices as the government and industry grapple with the changes in the economy. We can already see in today’s Iowa caucus that the Republican presidential candidates most discussed topic is jobs. Politicians will continue to pin the blame on fat-cat bankers for quite a while. They make an easy target.

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