Month: September 2013

September 11

"Tribute in Light" from the US Air Force
“Tribute in Light” from the US Air Force

The September 11 attacks resulted in the deaths of 2,996 people, including the 19 hijackers and 2,977 victims. The victims included 246 on the four planes, 2,606 in New York City in the World Trade Center towers and on the ground, and 125 at the Pentagon. Nearly all of the victims were civilians. 55 military personnel were among those killed at the Pentagon. One was an employee of my company.

Make a few minutes today to remember those lost directly, and as a result of the subsequent actions. Thousands more Americans were killed in Afghanistan to attack the perpetrators of this criminal act.

Make a few more minutes to think about how our country has eroded some of it’s citizens’ civil liberties as a response to the threats, real or perceived, that may come. The NSA spying scandal, the TSA procedures at the airport, the militarization of our police forces, any many other negatives have spilled into America culture as a result of those September 11 attacks.

Publicly Traded Partnerships and a Qualified Matching Service

QMS

If a fund has frequent transfers by its limited partners, it risks being classified as a publicly traded partnership. That’s a bad result because the fund then becomes taxable as a corporation, subject to a qualifying income test. You might be surprised how low the threshold is for being treated as a publicly traded partnership.

A partnership is treated as a PTP if (i) interests in the partnership are traded on an established securities market, or (ii) interests in the partnership are readily tradable on a secondary market or the substantial equivalent thereof. The big problem is determining when you have a “substantial equivalent” of a secondary market. Under the regulations, the IRS uses a facts and circumstances test to determine if “partners are readily able to buy, sell, or exchange their partnership interests in a manner that is comparable, economically, to trading on an established securities market.” You hate to get into a facts and circumstances discussion with the IRS.

One safeguard in the implementing regulations at 26 C.F.R. § 1.7704-1 is a de minimis trading exception. 26 C.F.R. § 1.7704-1(j) provides for interests in a partnership to be deemed not readily tradable on a secondary market or the substantial equivalent thereof if the sum of the percentage interests in partnership capital or profits transferred during the taxable year of the partnership does not exceed 2 percent of the total interests in partnership capital or profits.

Two percent is a very low threshold.

If you get close to that number there are several transfers that are disregarded transfers for this safeharbor, including:

  • block transfers by a single partner of more than 2% of the total interests
  • intrafamily transfers
  • transfers at death
  • distributions from a qualified retirement plan
  • Transfers by one or more partners of interests representing  50 percent or more of the total interests in partnership

Another option is the use of a Qualified Matching Service (QMS).

If transfers are made through a “qualified matching service,” up to 10% of the interests in a partnership can be transferred during the partnership’s taxable year without resulting in the partnership being a PTP.

Under Section 1.7704.1(g) a a qualified matching service has to meet the following standards:

(i) The matching service consists of a computerized or printed listing system that lists customers’ bid and/or ask quotes in order to match partners who want to sell their interests in a partnership (the selling partner) with persons who want to buy those interests;

(ii) Matching occurs either by matching the list of interested buyers with the list of interested sellers or through a bid and ask process that allows interested buyers to bid on the listed interest;

(iii) The selling partner cannot enter into a binding agreement to sell the interest until the 15th calendar day after the date information regarding the offering of the interest for sale is made available to potential buyers and such time period is evidenced by contemporaneous records ordinarily maintained by the operator at a central location;

(iv) The closing of the sale effected by virtue of the matching service does not occur prior to the 45th calendar day after the date information regarding the offering of the interest for sale is made available to potential buyers and such time period is evidenced by contemporaneous records ordinarily maintained by the operator at a central location;

(v) The matching service displays only quotes that do not commit any person to buy or sell a partnership interest at the quoted price (nonfirm price quotes) or quotes that express interest in a partnership interest without an accompanying price (nonbinding indications of interest) and does not display quotes at which any person is committed to buy or sell a partnership interest at the quoted price (firm quotes);

(vi) The selling partner’s information is removed from the matching service within 120 calendar days after the date information regarding the offering of the interest for sale is made available to potential buyers and, following any removal (other than removal by reason of a sale of any part of such interest) of the selling partner’s information from the matching service, no offer to sell an interest in the partnership is entered into the matching service by the selling partner for at least 60 calendar days; and

(vii) The sum of the percentage interests in partnership capital or profits transferred during the taxable year of the partnership (other than in private transfers described in paragraph (e) of this section) does not exceed 10 percent of the total interests in partnership capital or profits.

A fund sponsor can theoretically set up its own QMS to allowing greater liquidity in interests in its partnerships than permitted by the 2% safe harbor.

Sources:

Compliance Bricks and Mortar for September 9

compliance bricks and mortar

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

Bad news. You’re promoted to compliance officer by Michael Scher in The FCPA Blog

It’s not right to lump together all compliance officers. We have to recognize that those working in America are nearly on another planet from COs working in Asia, Africa, Latin America, Russia and many other countries. While all compliance officers may be speaking the “same language,” the conditions of speaking truth to management or regulators are incomparably different.

Where is Crowdfunding? by Dave Lynn in The CorproateCounsel.net

Well over a year after the enactment of the JOBS Act, we still await movement on the SEC’s rulemaking under Title III, which provides the framework for exempt crowdfunding offerings to non-accredited investors, subject to a $1 million cap over a rolling 12-month period and dollar limits based on an investor’s financial position. As this Washington Post article notes, the SEC Staff has indicated that crowdfunding rules can be expected sometime this fall, however these would presumably be proposed rules, meaning that final rules could not be expected until well into 2014 at the earliest when you factor in the need for FINRA to also create a regulatory system for funding portals. As a result, the ability to do exempt crowdfunding offerings remains limited, except that many are anticipating the ability to do more accredited investor-only crowdfunding offerings once general solicitation is permitted under Rule 506 after the September 23, 2013 effective date of those JOBS Act mandated rule changes.

More Questions About General Solicitation by Joe Wallin in Startup law Blog

There is a lot of confusion about the SEC’s new rules that will allow, starting September 23rd, the general solicitation and general advertisement of private company securities offerings under Rule 506(c) of Regulation D.

Send in the Clowns – the NCAA and its Investigation of Johnny Football by Tom Fox in FCPA Compliance and Ethics Blog

How can you determine if an organization charged wijth compliance is corrupt or simply incompetent? It is hard today to answer that question when it comes to the National Collegiate Athletic Association (NCAA) and its enforcement division. For those of you do not know the story, the NCAA was investigating last year’s Heisman Trophy winner, Johnny Manziel a/k/a Johnny Football, for allegedly signing autographs for money, which is a violation of the near slavery conditions that NCAA scholarship athletes find themselves in today.

Discovering Empty Mansions

empty mansion

If you’ve ever been house hunting, you’ve likely spent some time looking at houses way out of your price range. Bill Dedman did the same thing. He discovered Le Beau Chateau, a $24 million mansion containing almost 15,000 square feet on 52 acres. The property taxes alone were $161,000 per year. But what really caught his eye was that the property had been unoccupied since the owner bought it. In 1951.

Dedman, a Pulitzer Prize–winning journalist, smelled a story.

He discovered the owner of the property was Huguette Clark, and she owned another, bigger mansion in Southern California that had also sat vacant for decades. There was definitely a story here. It became Empty Mansions.

Ms. Clark’s father was W.A. Clark, a copper miner, railroad entrepreneur, and a U.S. Senator. In the early 20th century he was one of the wealthiest men in America.

Ms. Clark’s homes had not sat vacant because she was dead. Dedman found her alive, “happily” living for the prior two decades in a New York City hospital room.

Dedman puts together a great history of W.A. Clark, how he amassed his fortune, and how he extravagantly spent some of that wealth. The middle of the story focusing on the decades of Huguette’s life runs a bit flat. That would seem to happen because she lived such an intensely private life and lived as a recluse. The story loses some flair because there is no flair there.

The story once again gets interesting as Ms. Clark gets admitted to the hospital after her health deteriorated, her staff had all retired, and there was no one to take care of her. She seemed to enjoy the hospital and took up permanent residence, even though there seemed to be no medical reason to stay.

Ms. Clark is over 100 years old by the time the her story comes out. Everyone starts wondering what will happen to her fortune and many want a piece of it. Many of the likely beneficiaries want a bigger piece. Her relatives had little contact with her over the prior decades. It’s a mess that I’m sure a trust and estates lawyer could use as a learning tool for recalcitrant clients.

The ethical and compliance issues come to the front. Ms. Clark begins giving millions to her nurse. It seems to be a violation of hospital policy. Dedham portrays the hospital to be itself looking to be a recipient of Ms. Clark’s generosity. Perhaps they are even hiding her from auditors who would question why she has not been discharged.

I think Dedham pulls some punches at the end because the estate is still unsettled and the potential liability is still in play. It’s hard tell if Ms. Clark was of sound mind when she was writing her will or whether she was unduly influenced by her advisers and caregiver.

It’s an interesting story and a well-written book.

Picking Cherries

cherry picking

As an investment adviser, you can’t take the best investments for yourself and leave the lesser ones for your clients. That’s exactly what the Securities and Exchange Commission is accusing J.S. Oliver Capital and Ian O. Mausner of doing.

The SEC’s Enforcement Division is alleging that J.S. Oliver and Mausner engaged in a cherry-picking scheme that awarded more profitable trades to favored clients. Meanwhile they doled out less profitable trades to other clients, including a widow and a charitable foundation. (You have to love the SEC’s highlighting a widow and a charity as victims. If only the charity were for orphans, then the cliche would be perfect.)

Mausner financially benefited from the cherry-picking scheme because he and his family were personally invested in the hedge funds. Plus, he earned additional fees from one of the hedge funds based on the boost in its performance as a result of the cherry-picking. Mausner profited by more than $200,000 in fees earned from one of the hedge funds based on the boost in its performance from the winning trades he allocated.

This cherry-picking scheme is the classic failure to allocate trades before they are made. Mausner made block trades in omnibus accounts at various broker-dealers. The block trades were reported to J.S. Oliver’s prime broker and then Mausner allocated the shares among the client accounts. According to the SEC complaint Mausner often delayed allocating trades until after the close of trading or the following day, allowing him to determine which securities had appreciated or declined in value.

Even if Mausner was trying to allocate trades on a fair and equitable basis, the mere fact that trades were not allocated until after they made makes the process suspect. Then you have the uphill battle of proving you were fair, when in hindsight better trades ended up in favored accounts.

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Finding the Signal Though the Noise

signal and the noise

Nate Silver came into fame for his forecast of the presidential election in 2012. That matched his success in 2008 for also getting the presidential election correct. His book, The Signal and the Noise, is built upon that success.

We learn that Silver is not a political pundit, but a numbers geek. He started with statistical analysis of baseball while toiling away for the accounting firm KPMG. The next step was online poker, using his analysis to be a better poker player. That made him a lot of money, for a while. Then he turned to political analysis where he caught broader attention.

But the book is not a biography, or pages of Silver trumpeting his own horn. It’s a book about the success and failures of using data to forecast future events. Silver slices the data into two categories. The Signal is the truth and the Noise it what distracts us from the truth. In today’s market, information is not a scarce commodity. However, we perceive it selectively and subjectively. Our biggest failure is not paying attention to our own distortion. We never make perfectly objective predictions. They are always tainted by our subjective point of view.

Silver looks at the statistical analysis used in several fields:

  • the housing bubble and mortgage securities crisis
  • television political pundits
  • baseball
  • weather
  • earthquakes
  • economic forecasts
  • flu epidemics
  • poker

Taken from a scientific perspective, predictions can be tested. Silver tests them.

For example, look at weather forecasts. If the forecast calls for a 20% chance of rain, it should rain on 20% of the days that have that prediction. Silver backtests the performance of weather forecasters. He finds that some consistently over-forecast rain, raising a 5% chance to 20%. That way the audience will be less disappointed if it rains. Silver also compares long term forecasts to average conditions for that day. It turns out that the long term forecast is more likely to be wrong than merely relying on the historic average.

But weather forecasting has improved. Hurricane prediction is an area that has seen measurable improvement. Over the past 25 years the hurricane landfall prediction for three days in advance has decreased from a 350 mile radius to a 100 mile radius.

There is plenty in this book for compliance professionals. The first topic in The Signal and the Noise is the rating agencies and the financial crisis of 2008. He uses an example of S&P’s rating of CDO tranches. In achieving the AAA rating, S&P predicted that there was only a 0.12% probability that it would fail to pay out in the next five years. The reality is that the failure was 28%. The actual default rate was more than 200 times higher than predicted.