Month: August 2012

Compliance Bits and Pieces for August 3

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

Four Signs Your Awesome Investment May Actually Be A Ponzi Scheme by Theo Francis in NPR’s Planet Money

[I]t turns out that the Ponzi industry is much broader and deeper than even the biggest blowups suggest. That’s one lesson of a slim new book, The Ponzi Scheme Puzzle: A History and Analysis of Con Artists and Victims, from Boston University Law Professor Tamar Frankel.

Should dentists and lawyers be rotated, like auditors? by Jeff Kaplan in the Conflict of Interest Blog

As a general matter, the professional relationships that expert service providers (e.g., doctors, lawyers, accountants) have with those they serve carry the potential for conflicts of interest, at least, where the provider’s advice can impact how she is paid. Of course, we rely on providers’ professional standards of conduct to mitigate those conflicts. Beyond this, we tend to think that having a good personal relationship with an expert provider will serve as a useful “inner control,” and steel the provider against the potential for COIs inherent in the very economic nature of the relationship.

Too bad that it apparently doesn’t work.

When Your Investment Target Has Drug Cartel Ties by Nick Elliott in WSJ.com’s Private Equity Beat

The firm had done some due diligence and found the businessman had a strong record going back eight years. Springer’s firm formed the same impression, but Springer said he was suspicious that there was no information before that time, so he asked the firm for more time to dig deeper.

Knight Capital Says Trading Glitch Cost It $440 Million by Nathaniel Popper in NYTimes.com’s DealBook

$10 million a minute.

That’s about how much the trading problem that set off turmoil on the stock market on Wednesday morning is already costing the trading firm. The Knight Capital Group announced on Thursday that it lost $440 million when it sold all the stocks it accidentally bought Wednesday morning because a computer glitch. The losses are threatening the stability of the firm….

Loss Swamps Trading Firm in the Wall Street Journal

Knight officials blamed software installed earlier this week for causing the brokerage firm to enter millions of faulty trades in less than an hour on Wednesday morning. The orders roiled trading in almost 150 stocks and left Knight holding losing positions in many shares at the end of Wednesday’s trading session.

Knight Capital trading debacle shows Wall Street frailties by Andrew Tangel and Jim Puzzanghera in the Los Angeles Times

The high-speed trading arms race being waged on Wall Street has finally claimed its first major casualty.

Knight Capital Group, a brokerage that handles nearly 11% of all stock trading in U.S. companies, is in danger of collapsing after a software glitch triggered millions of unintended orders. The New Jersey firm lost $440 million in less than an hour — nearly four times the company’s profit last year.

Badminton Falls Down

Bazuki Muhammad/Reuters

Few in the United States watch Olympic badminton. Fewer still are likely to watch after the ridiculous play in preliminary games. (Maybe a few will try to watch, just as a few slow down to watch the results of a car accident on the side of the road.) Four of the best teams in the world were kicked out of the Olympics for intentionally trying to lose matches and gain a competitive advantage. Clearly the competition was poorly structured if there was an incentive to lose.

This year the Olympics switched to a round-robin tournament, replacing the one-and-done format, so teams compete in three round-robin games before seeding them in medal brackets. There are four pools of four teams. The top two teams in each pool qualify for the quarterfinals and the bottom two spend the rest of the competition in the Olympic village.

China’s Wang Xiaoli and Yu Yang won their first two matches and secured a spot in quarterfinal. Their final match against a South Korean team would determine first and second place in Pool A.

The first complication came when the other Chinese team, Qing Tian and Yunlei Zhao, lost to Denmark in an big upset. That placed the Chinese team on the same side of the bracket as the winner of Pool A. If both Chinese teams won their quarterfinal matches, they’d meet in the semifinals and only one would make it to the finals. At best that’s gold and bronze, not gold and silver.

To avoid this situation, the Wang and Yu tanked their game. The South Koreans did not want to meet the other Chinese team so they tanked also. At one point the four players traded 6 service errors in a row. Five went directly into the net. The one that made it over made in way over and went long off the back line. That’s much more like how I play in the backyard.

After the Chinese tried to throw their match, the South Korean team of Ha Jung-eun and Kim Min-jung faced the Indonesian team of Meiliana Jauhari and Greysia Pollii in Pool C. Both teams adopted a similar losing strategy to avoid having to face the fearsome Wang and Yu. (Watch the video and you can see that they were not trying.)

A well designed tournament should eliminate strategic losses. Getting a higher seed should convey a benefit, generally it means you play someone who isn’t as good. Pool play to determine seeding means more games and allows a margin of error for a team. Clearly the Olympics missed something.

The NBA tried to eliminate an incentive to lose by implementing a draft lottery instead of merely giving the highest draft pick to the team with the worst record. The NFL gives an incentive to win by giving the teams with the best record a week off before the playoffs. That still leaves some lackluster games at the end of the season when teams pull their starters.

Strategic losing does not appear to be a new strategy in badminton. Statistics show that more than 20 percent of matches is either not finished or not played when the Chinese play against their own compatriots. They met each other 99 times on the circuit in 2011, and 20 matches were either not played at all or played partially before one of the opponents retired. This shows that 20.20% of matches between Chinese shutters were not completed in 2011. But only 0.74% of matches were uncompleted between China and other nations.

What does this have to do with compliance? Look at your internal structures and incentives. Are any designed to allow an incentive to fail. Do any give incentive for one business unit to cause another to fail?

Sources:

 

Don’t Trade Stock in Your Friend’s Company, Illegally

Ladislav “Larry” Schvacho purchased approximately 72,000 shares of Comsys IT Partners, Inc. stock between November 9, 2009 and February 1, 2010. On February 2, 2010, Manpower, Inc. and Comsys publicly announced a merger, resulting in a 31% percent increase in the share price of Comsys from its prior day’s close. As a result of his trading in Comsys stock, Schvacho obtained profits of  over $500,000.

The SEC thinks Schvacho made those trades because he was a friend of the CEO of Comsys and was illegally trading on inside information. At this time, Schvacho is contesting the charges so the allegations may or may not be true. I’m assuming they are true to see if we can learn some lessons from this case.

Schvacho and Larry Enterline worked at several companies together starting in the 1970s, including an investment fund. They also developed a close personal relationship and Enterline named Schvacho as executor of his estate. Enterline was the CEO of Comsys.

According to the SEC complaint Enterline was not cautious in speaking about the company’s business when Schvacho was around. Enterline spoke on the phone to other Comsys executives about the merger in the presence of Schvacho. The SEC also alleges Schvacho had access to merger-related documents during a vacation with Enterline.

The transactions smell like insider trading. The easiest problem for the SEC will proving that Schvacho knew about the confidential merger information. From the statements in the complaint it sounds like Enterline has provided the SEC with some specific information about what was said in the presence of Schvacho.

The tough battle for the SEC will be proving that Schvacho had a duty to keep the information confidential and not trade in the stock. Schvacho himself was not an insider. He was merely the friend of an insider. The SEC contends that “Enterline reasonably expected that Schvacho would refrain from disclosing or otherwise misusing the confidential information.” The SEC will have to show that Schvacho violated a fiduciary duty to Enterline based on their long friendship. That duty is part of the law of insider trading cases under 10b-5.

Even if the SEC cannot show insider trading, the SEC also accused Schvacho of violating Rule 14e-3, which prohibits insider trading on information about a tender offer. Unlike insider trading, Rule 14e-3 does not require proving a breach of a fiduciary duty, The SEC will merely need to prove that the person knew the information was confidential. This was just luck for the SEC in this case. The Comsys transaction happened by a tender offer instead of the more traditional merger or reverse merger.

Sources: