Month: March 2014

Weekend Reading: Sycamore Row

Sycamore_Row

I went to law school in the early 1990s so I’m supposed to be a John Grisham fan. The lure of doe-eyed law school graduates getting hired by big law firms paying big salaries was shadowed by the sinister practices in The Firm.

I did read Grisham’s first few books and stopped. I enjoyed the writing the plots were less intriguing.

Someone recommended that I read his latest novel, Sycamore Row.

He goes back to the setting and characters from his first book, A Time to Kill. It’s three years after the murder trial and Jake Brigance is still practicing law in Ford County, Mississippi. Jake gets handed a will contest that is tainted with race and just a touch of mystery.

I have to admit that I have a hard time reading the book and not envisioning Matthew McConaughey speaking Jake’s dialogue. That means I kept waiting for “Alright, Alright, Alright.”

Like most sequels, Sycamore Row is not as good as the first novel. But if you like John Grisham, or at least A Time to Kill, you’ll enjoy this one.

It was good bus-ride reading.


Compliance Bricks and Mortar for Pi Day

pi day

Exploratorium physicist Larry Shaw began celebrating March 14 as pi day for the mathematical constant π, the ratio of a circle’s circumference to its diameter.

Behind the Myth of Insider Trading by SEC Employees by Bruce Carton in Compliance Week

The authors also point to six specific cases in which “SEC employees appear to front-run the announcement that a firm is subject to costly SEC penalties (associated with the enforcement action).” The authors conclude that “at least some of these SEC employee trading profits are information based, as they tend to divest in the run-up to SEC enforcement actions …” From that bold conclusion came the breathless media headlines mentioned before.

Do the assertions, assumptions, and conclusions in this study even make sense? I say no—let me count the ways: …

The SEC Will Take “Your” Money, Thanks by David Smyth in Cady Bar the Door

So let’s say you work for a hedge fund or some other financial institution that engages in proprietary trading , and you’re inclined to do some insider trading on your employer’s behalf.  You make your trades, but you’re a company man and the profits go to the fund, not your own pocket.  And let’s also say you get caught and the SEC sues you for the illicit trading.  Not a very fun thought so far, right?  It gets worse.  Because if the SEC wins its case, it can force you to disgorge your fund’s profits.

The Ides of March and Evaluation of Compliance Risk by Tom Fox in the FCPA Compliance and Ethics Blog

One of the more interesting questions in any anti-corruption compliance regime is to what extent your policies and procedures might apply in your dealings with customers. Clearly customers are third parties and in the sales chain but most compliance programs do not focus their efforts on customers. However, some businesses only want to engage with reputable and ethical counter-parties so some companies do put such an analysis into their compliance decision calculus.

However, companies in the US, UK and other countries who do not consider the corruption risk with a customer may need to rethink their position after the recent announcements made by Citigroup Inc. regarding its Mexico operations.

The Disturbing Economics Of Automobile Dealerships in Weakonomics

Tesla, the maker of the car you see above, is in a bit of a pickle with the state of New Jersey.  The automaker is an industry innovator; not just for the fact that it makes beautiful electric cars, but because they also want to sell those cars directly to their customers.  In the United States this idea is not only rare, it’s largely illegal.  For the past few years Tesla has been battling with lawmakers and trade-groups state by state for the right to sell cars directly to their customers.  The opponents in this case are the car dealers, who want to force Tesla use dealer networks to distribute and sell their cars.

Non-Technologists Agree: It’s the Technology by Andrew McAfee

Two papers came out last year that examined important issues around jobs and wages. Both are in top journals. Both were written by first-rate researchers, none of whom specialize in studying the impact of technology. And both came to the same conclusion: that digital technologies were largely responsible for the phenomena they examined.

Another Modest Proposal – Risk Factors by Keith Paul Bishop in California Corporate & Securities Law blog

Here’s my solution. The Securities and Exchange Commission should create a list of standard risk factors and issuers should be required to incorporate by reference all applicable risk factors into their filings. They would only be permitted to disclose risks that aren’t on the list. Thus, the SEC would create a standard risk factors such as “competition”, “dependence on key personnel”, and “natural disaster”.

Planning: are you running a baseball game or a soccer match? by Jack Vinson in Knowledge Jolt with Jack

When planning a project, are you more interested in the dates every activity happens, or are you more interested in how all the activities are connected together? Which focus will guarantee success?

The answer depends a little on what kind of work you are planning. Event-based planning focuses on the sequence of activities needed to complete the project. Time-based planning focuses on the time available and attempts to get as much done as possible, according to the clock.

Get Ready for the SEC to Knock on Your Door

Grim Reaper Door Knocker

With the SEC’s presence exam initiative for new registrants and the Never-before-examined initiative for existing registrants, the odds have never been greater that the SEC will knock on your door and start an examination. I’ve also heard from a friend that the SEC is coming in for a full blown examination of her firm. (I also heard an SEC examiner mention that they are going to try to ferret out private fund managers who did not register.)

Obey the Boy Scout Motto and be prepared.

Prepare an introductory presentation. As I discussed last week, start drafting that presentation now, before the SEC knocks on the door. Circulate it broadly to get comments. Review it each quarter to keep it up-to-date. You are not going to have enough time to create presentation once you get SEC’s knock on your door.

Practice getting the documents ready for an exam. Grab a recent SEC document request list and give yourself a week to get all of the documents assembled. You may find it hard to answer some of the questions, so you can change your record-keeping process to address a likely question. You will also have a stockpile of documents ready to go when the SEC shows up.

Prepare some key employees. Look at your organization and figure out who the SEC examiners are likely to ask to speak with. They will want senior people in key risk areas. Valuation will be a big area for most real estate funds and private equity funds. Grill your valuation person so he or she is able to give a thoughtful presentation on your firms valuation process. Figure out who will do will being grilled by the SEC examiners and who will do poorly. Better to have that information now than in the crush of an SEC examination.

Prepare an examination procedure. Layout who gets notified and who is responsible for the various aspects of the examination. Think about where you want the examiners to sit while they are on site. Think about how you want to prepare and deliver documents.

References:

Do U.S. Regulators Listen to the Public?

listen

Regulators get piles of comment letters on proposed rules. But do the comments have an affect? Three math and finance professors tried analyzed the text of comments and regulations to find and answer.

Andrei A. Kirilenko, Shawn Mankad, and George Michailidis created a regulatory analytical tool called RegRank. The three researchers pointed RegRank at the CFTC and the 104 proposed rules the commission issued between January 2010 and September 2013. Those proposed rules resulted in 60,000 comment letters and 67 final rules.

The researchers used RegRank to rate a particular proposed rule, final rule and comments as pro-regulation or anti-regulation.  Then they use the tool to characterize how the CFTC rules evolved.

The data indicates that the regulators adjust the rules based on comments.

reg rank

There is a general pattern of a proposed rule becoming more in line with the calculated sentiment of the comment letters when it becomes a final rule.

References:

New Ruling on a Social Media Policy – Come on Down!

ernie boch

The National Labor Relations Board continues to wreck havoc on companies’ social media policies. That latest to get steamrolled in Boch Honda.

I grew up with Ernie Boch’s commercial proclaiming that his costs are less so his prices are less, so “come on down“.

Employers cannot prevent employees from discussing their conditions of employment with their fellow employees, radio and television stations, newspapers or unions. The NLRB will strike down provisions in social media policies that employees could reasonably construe as an unlawful prohibition.

The NLRB dismissed the following provisions, warranting “little discussion” that they are clear violations.

1. The Company requires its employees to confine any and all social media commentaries to topics that do not disclose any personal or financial information of employees, customers or other persons, and do not disclose any confidential or proprietary information of the Company.

2. If an employee posts comments about the Company or related to the Company’s business or a policy issue, the employee must identify him/herself…

5. If an employee’s online blog, posting or other social media activities are inconsistent with, or would negatively impact the Company’s reputation or brand, the employee should not refer to the Company, or identify his/her connection to the Company…

7. While the Company respects employees’ privacy, conduct that has, or has the potential to have a negative effect on the Company might be subject to disciplinary action up to, and including, termination, even if the conduct occurs off the property or off the clock.

8. Employees may not post videos or photos which are recorded in the workplace, without the Company’s permission.

9. If an employee is ever asked to make a comment to the media, the employee should contact the Vice President of Operations before making a statement.

10. The Company may request that an employee temporarily confine its social media activities to topics unrelated to the Company or a particular issue if it believes this is necessary or advisable to ensure compliance with applicable laws or regulations or the policies in the Employee Handbook. The Company may also request that employees provide it access to any commentary they posted on social media sites.

11. Employees choosing to write or post should write and post respectfully regarding current, former or potential customers, business partners, employees, competitors, managers and the Company. Employees will be held responsible for and can be disciplined for what they post and write on any social media. However, nothing in this Policy is intended to interfere with employees’ rights under the National Labor Relations Act.

12. Managers and supervisors should think carefully before “friending,” “linking” or the like on any social media with any employees who report to them.

You can take a look at other social media policies in my social media policies database.

References:

Do Law Firms Need Compliance Programs?

Dewey-LeBoeuf compliance

Do as I say; Not as I do.

The bankruptcy of Dewey & LeBoeuf sent shivers throughout big law firms. The firm could trace its history back 100 years and employed over 1000 lawyers when it exploded. Last week, key leaders of the firm were charged with securities law violations and criminal theft charges related to the law firm’s bond issuance.

When Dewey went under, the first thing that caught my eye  was its bond issuance. That seemed an unusual way for a law firm to finance its cash flow and capital needs. Unfortunately for the Dewey leaders, its one thing to lie to the firm’s partners and lenders about the firm’s financial health. But the lying to the bond purchasers is securities fraud.

According to the indictment and SEC complaint, the firm was behind on its lender covenants and started reclassifying items to make its financial statements meet the targets. In reading through the charges, some of those accounting adjustments sound bad and some sound questionable. An accountant would probably not approve, but that Dewey managers may have some arguments to justify the changes.

“I assume you new [sic] this but just in case. Can you find another clueless auditor for next year?”

Oh my… What would a lawyer say to his client who put something like this in an email?

What ever argument the Dewey managers may have had about the accounting treatment is going to be questioned when there are emails discussing the decisions with phrases like: “fake income”, “accounting tricks” and my favorite: “cooking the books”. At this point, we only have the government’s side of the story and the Dewey managers have not had a chance to tell their side of the story.

There is an email asking for back-dated checks so the firm can book revenue to the prior year in an effort to make 2009 year-end numbers. That is followed by a response from another manager asking the email to be re-worded so it does not sound like it’s engaging in accounting fraud.

The firm is not meeting its financial goals. That’s disappointing and the its lenders are going to reel the firm in. The solution was a bond offering. According the SEC and district attorney, the firm’s financial statements were fraudulent.

This seems like a classic “company gone bad” fraud scheme. The firm insists on making its numbers and pushes its accounting treatment to make the numbers in that quarter, but ends up robbing income from the following quarter. It hopes it can catch up, but never does.

The firm managers had been fraudulently claiming revenue that Dewey did not have and kept pushing expenses and financial obligations off into the future. Dewey had to cut partner compensation and that was not enough to prevent them from leaving. With the loss of partners, there was a loss of revenue. At some point the rubber band is stretched too far (not that law firms are that flexible) and snaps. The firm managers could no longer fool Dewey’s lenders and bond holder. It had no choice but to file bankruptcy, sending thousands onto the unemployment line.

But this was a law firm who, on a regular basis, dispensed advice about compliance and SEC enforcement and accounting fraud. As Donna Boehme and Joseph Murphy point out in 10 Inconvenient Truths About Law Firm Compliance (.pdf):

Fact 1: People create risks. Fact 2: Law firms have people.

It seems like Dewey had a case of not following the advice it dispensed to its clients.

References:

Weekend Reading: Wheelmen

wheelmen

There are compliance lessons to be learned in Wheelmen: Lance Armstrong, the Tour de France, and the Greatest Sports Conspiracy Ever by Reed Albergotti and Vanessa O’Connell.

Lance Armstrong was one of the best cyclists in last 20 years. But his wins were built on a foundation of illegal doping and performance enhancing drugs. It’s not about the bike; It’s all about the needle.

Reed Albergotti and Vanessa O’Connell write a devastating tale of Mr. Armstrong’s rise and meteoric crash. Wheelmen is very well-written and well-researched. We only saw Lance on his bike. The book takes us through what was happening on the team bus and hotel.

I’m cyclist and a fan of cycling races. I first came to road cycling during the rise of Mr. Armstrong. His story as a cancer-survivor coming back to win the biggest race in the world was an inspiration. I remember watching his epic battles with Ullrich, Mayo, Beloki, and himself. Lance answered all the challenges during his seven Tour de France wins in a row. His team was stacked with great riders: Hincapie, Hamilton, Landis, Eki, Heras, Leipheimer, and many others. The team was run by a Bruyneel, a master tactician.

Those great riders and those tactics were reliant on a widespread campaign of illegal doping. The United States Anti-Doping Agency has stripped Armstrong of all of his cycling wins since his recovery from cancer.

It’s clear that most of the top cyclists during the Armstrong era were also doping. There are no Tour de France winners during those years because the men next to Armstrong on the podium most years have also been implicated in doping. It begs the question of whether Armstrong was the best cyclist or merely the best doper. Or perhaps a combination of the two.

I was sadly disappointed when the charges came out against Armstrong. Given that he had faced death, I did not think he would risk his health by doing.

“Armstrong said he wouldn’t be stupid enough to take drugs after cancer. ‘I’ve been on my deathbed,’ he said.”

It was like discovering the truth about Santa Claus.

The biggest compliance failure was that the cycling organizations had no incentive to investigate Armstrong. He was bringing media attention and fans to the sport. That meant more money for cycling. If they brought down their biggest star, the racing organizers and governing bodies would have lost money.

Good compliance programs have good testing. The cycling federations had poor testing. The riders knew how to stay ahead of the tests.

Armstrong provides an insight to the workings of a sociopath. Armstrong’s interview with Oprah was the window into the mind of a pathological liar. Armstrong had been telling the lie over and over and over. He lied to the public. He lied to the press. He lied to cancer survivors. He lied under oath.

He even lied about the testing. He proclaimed that he had been tested clean over 500 times. According to the authors of Wheelmen, the true number is half of that.

Wheelmen is great book to read if you have an interest in cycling or Lance Armstrong.


Compliance Bricks and Mortar for March 7

bricks 7

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

Machiavelli for Chief Compliance Officers by Tom Fox in the FCPA Compliance and Ethics Blog

Lesson No. 1 – Heed Selected Advice from Selected Advisors

While in medieval Florence, the Prince ruled as the supreme monarch, he still needed advisors. Today, we are called subject matter experts (SMEs).

Two dubious ethical achievements by Jeffrey Kaplan in the Conflict of Interest Blog

First, a lengthy New York Times piece two days ago offered a “comprehensive examination” of the dealings of David Sampson, chairman of the Port Authority of New York and New Jersey and also a partner in the Wolff & Sampson law firm, with NJ Governor Chris Christie and his administration, both inside the Port Authority and out,  and detailed  ”the extent to which their ambitions and successes became intertwined.” The story concludes: “Mr. Samson and his law firm benefited financially. Mr. Christie benefited politically. And each enhanced the other’s stature as their relationship deepened in ways that were not apparent at the time.”

The SEC Has Never Prevailed In An FCPA Enforcement Action When Put To Its Ultimate Burden Of Proof by the FCPA Professor

This recent Wall Street Journal article highlighted how the SEC’s win rate at trials has slipped.  According to the article:

“[The SEC has] won 55% of its trials since October [2013], a sharp drop after three consecutive years when it prevailed more than 75% of the time.”

There has never been an SEC Foreign Corrupt Practices Act trial, but the above percentages are downright stellar when one considers that the SEC has never prevailed in an FCPA enforcement action when put to its ultimate burden of proof.

A Closer Look at Warren Buffet’s Letter to Berkshire Shareholders by Kevin LaCroix in the D&O Diary

Notwithstanding these results, it would be a mistake just to focus on the company’s relative performance during a single 12-month reporting period. Obviously, it is inherent in the nature of annual reports that the company in question will be considered in an annual snapshot perspective. But if Berkshire is only considered on this annual reporting period basis, a much more meaningful message might be overlooked. Simply put, Berkshire Hathaway is an astonishing company, and it is becoming even more so all the time.

Compliance Lessons From My Dog

Ghost and Doug

My dog has taught me a few lessons about compliance. (That’s me and Ghost taking a well-deserved nap.)

Start early. We started dog training early to focus on developing good habits at an early stage. (We did lose a few shoes while he was a puppy.) It’s never too late to unlearn bad habits, but it’s better to not have them in the first place.

He wants to do right thing. The dog does not act with malice. He just wants to be a loyal companion. He may stray from the right path because he’s presented with a new situation and doesn’t know how to act. Or he was presented with an irresistible temptation.

Remove the temptation. It would be great if Ghost didn’t grab food off the kitchen counter. He doesn’t do it when we are watching him. It only happens when he is unsupervised. We can blame the dog, but it was better to focus on removal of the temptation. We had to train ourselves to not leave food on the counter when the dog is not supervised.

Quick response. Our dog trainer taught us that we have only a few seconds to give praise for good behavior and to give a negative sign for bad behavior. Once too much time has passed the dog no longer equates his behavior with the reward or shunishment.

Appropriate Punishment. IMG_1163[1] Hitting a dog only makes him angry. If you have failed to mete out punishment quickly (see above) the punishment will not affect bad behavior. With one of my kids or one of my employees I could sit down and discuss the situation. Perhaps I could find an alternative way to get my point across.

What could I do after coming home to find a chewed up library book? It was too late for that book and it was too late for shunishment. All I could do is set a warning for others.

Consistency. Ghost is deaf so I rely on sign language and body language for communication. If I give him the “let’s go for a walk sign” I need to take him for a walk. If I give him the “come” sign, I expect him to come. If I’m half-hearted about the meaning of my signs, he’s going to be half-hearted about complying with them.

I’m sure there are more lessons to be learned from my dog.

Create an Introduction for the SEC

Welcome SEC Examiners

The chances are greater than ever that the Securities and Exchange Commission will show up in your lobby. Be prepared and have an introductory presentation for them.

The SEC’s Office of Compliance Inspections and Examinations is continuing on its presence exam initiative. Those exams are shorter which means the examiners can get to more fund managers. For those fund managers that registered before Dodd-Frank, OCIE is rolling out its new .

An introductory presentation is your chance to tell the examiners the story of your firm and the story of your compliance program. If done well, it can show the examiners that you are thoughtful about compliance and keep the examination focused on the right issues.

It’s not an investor pitch. You’re not trying to convince the examiners to invest with you. You are trying to convince them that there is no fraud, deception or manipulation at your firm.

Organize the presentation around a powerpoint and use it as your storyboard. The Chief Compliance Officer should lead the presentation. It may be useful to have one or two key employees present who are involved in the compliance program to help answer questions and take notes.

Put the powerpoint together today. Don’t wait for the SEC document request letter. You will be too busy gathering documents to put together the presentation. You can update the presentation each quarter to keep it up to date. When the SEC says they are coming, you merely need to polish the presentation and not create it from scratch.

Two good starting points are an investor pitch and annual meeting materials. Those should have background information and current investment information that you will want to include. Then you can layer in the compliance program information.