Month: June 2014

GM Shows That Lying Can Be Worse Than The Problem

GM and compliance

General Motors had a problem with its cars and didn’t fix it. Then the company apparently tried to cover up the mistake and lied about the mistake. As a result, GM lost the story and ended up with a headline of GM Lied and People Died.

The problem seems to come from a mistake made by an engineer in designing the ignition switch design. He approved the design even though it failed to meet GM’s standard on torque requirements. The result is that the key could inadvertently move out of position, affecting power brakes, power steering and air bags.

That engineer authorized a switch redesign after problems surfaced. However, he did not assign a new part number, making it impossible to track any changes to the part. As the defect became apparent, GM compounded the engineer’s problem by failing to fix the problem.

So far 13 deaths and 32 crashes have been linked to the defect. GM has repaired more than 113,000 cars out of a total 2.6 million worldwide under the switch recall.

Because of the lies and cover-up, GM loses the ability to tell a more nuanced story about the defect.

Car and Driver tested the effects of the key defect and the results do make it sound like the car turns into a death trap. For brakes, with a full failure, the effort to stop the car increased from 51 pounds to 220 pounds. That’s a big push but achievable by most people. The magazine’s tests resulted in 3 more feet of stopping distance.  That increase is after a complete shutdown. The brakes will still have some boost after the engine shuts off.

Steering effort increases from a range of 3.3 pounds to 8.0 pounds up to 15.1 pounds to 29.2 pounds.  That increase in manageable for most people.

For years, people were driving cars without power steering and power brakes. Of course, the sudden loss of power can lead to panic and increase the risk of an accident. As it likely did in the 32 linked crashes.

The airbags deployment is also a more nuanced position. The airbags can deploy when the key is not in the “on” position. Cars are loaded with sensors that trigger the decision to deploy the airbags. A misfired airbag can be dangerous. So in many models, the airbags do not deploy when a person is out of position in the vehicle. This is particularly true when a passenger is not restrained by a seatbelt.

At least seven of the thirteen victims were not wearing their seatbelts. That increases the chances that the airbags would not deploy, even if the key was in the “On” position.

At least four of the drivers were under the influence of drugs or alcohol at the time of the accidents. That will decrease their ability to properly react to the defective shutdown after the key moves.

But GM lost the ability to control the narrative. The company manufactured a vehicle with a known defect and then failed to fixed the defect after it was discovered. The dominant narrative that the cars turned into uncontrollable deathtraps doesn’t hold up. But GM is stuck addressing its internal problems with the media and regulators.

The lies made the problem many times worse for the company.

References:

Compliance Bricks and Mortar for June 6

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

The key to hedge-fund riches: your retirement dollars by Timothy Spangler in The Guardian

First, there is the misconception that “there are no restrictions on what they can invest in.” This is true. They can invest the same way Sir Richard Branson or your Aunt Edna can invest, if they had the money and the expertise. They are not given a special pass to avoid all of modern Wall Street regulation that applies to ever trader out there. But, since retail investors are excluded, hedge funds don’t have to submit to any of the “bubble wrap” restrictions that the SEC puts on mutual funds and other products meant for retail investors.

SEC, Bitcoin and Unregistered Offerings by Thomas O. Gorman in SEC Actions

Bitcoin has been a much discussed item recently. The virtual currency is a digital representation of value that is traded and can serve as a medium of exchange. There are websites that use it. At one time there was a stock exchange called the Global Bitcoin Stock Exchange which apparently listed shares valued in the medium but is now out of business. And, there are trading platforms that use bitcoin such as the MPEx based in Romania.

Now the Commission has brought an administrative proceeding involving two offerings of unregistered securities valued in bitcoin.

The SEC’s (New) Admissions Policy: Questions and Consequences by Nancy Adams in Securities Litigation & Compliance Matters

Nearly a year has passed since the SEC announced that it would require admissions of wrongdoing as a condition of settling SEC charges in certain cases. Perhaps it can no longer be called a “new” policy. But lawyers are still wrestling with questions about the policy and its consequences – both intended and unintended. How broadly does the new policy apply? How and when should the question of its application be addressed in a case?

FATCA: What it is, and why it may apply to your business by Stephanie Quiñones in The Securities Edge

The Foreign Account Tax Compliance Act (“FATCA”) is a US law designed to counter offshore tax avoidance by US persons. Controversial because of its wide-ranging breadth and application to non-US financial institutions, in the most general sense, FATCA imposes a 30% withholding tax on payments of US source income made to foreign financial institutions (“FFIs”) unless they enter into an agreement with the US Internal Revenue Service (“IRS”) and disclose information about their US account holders.

Massachusetts, Illinois surveying RIAs about cybersecurity by Minda Smiley in Investment News

“Many of the RIAs are smaller and we want to get their input to see what exactly they feel they have and what they might need,” said William Galvin, secretary of the Commonwealth of Massachusetts. “We want to see what kind of protections are in place and if additional protections are needed, we want to prescribe what they should be.”

Do You Want Your Lawyer To Be Horatius Or Atticus Finch? by Keith Paul Bishop in California Corporate & Securities Law

Lawyers should be treated differently from accountants because their roles and professional obligations are fundamentally different. Simply put, lawyers are not gatekeepers. To foist the role of gatekeeper on private attorneys undermines the critical role that lawyers play in our polity as advocates for their clients and checks on the government. The former Soviet Union had lawyers, but they all worked for the government. By labeling lawyers as gatekeepers and threatening enforcement, the government is in effect saying “you work for us”.

Judge Rakoff Reversed by Second Circuit on SEC-Citi case, Still Sort of Wins by David Smyth in Cady Bar the Door

And yet, it turns out Judge Rakoff was wrong the whole time.  By essentially insisting on admissions to the facts alleged in the SEC’s complaint, Rakoff exceeded his authority as a district judge.  According to the Second Circuit today, here is what a court evaluating a proposed SEC consent decree for fairness and reasonableness should assess: (1) the basic legality of the decree, (2) whether the terms of the decree, including its enforcement mechanism, are clear; (3) whether the consent decree reflects a resolution of the actual claims in the complaint; and (4) whether the consent decree is tainted by improper collusion or corruption of some kind.  Of course, a district court may need to make additional inquiry to ensure the decree is fair and reasonable.  Indeed, it shouldn’t be a “rubber stamp.”  But the primary focus should be on ensuring the decree is procedurally proper and take care not to infringe on the SEC’s discretionary authority to settle on a particular set of terms.

Spot the Fraudster

valente and eliv

One of the challenges that consumers face when dealing with a financial adviser is what it means to be a “financial adviser.” The terms financial planner, wealth consultant, stockbroker, investment adviser, financial consultant, and others get thrown around, leaving you how that person gets paid for helping you with your money. A fraudster may sling around those terms and get paid by taking your money instead of investing it.

What to do when someone claims his firm is “an accredited investment and consulting firm specializing in wealth creation and preservation”? I know to run to FINRA’s BrokerCheck and the SEC’s Investment Adviser Search for diligence. In this case, you find red flags.

The Securities and Exchange Commission alleges that Scott Valente and his firm The ELIV Group LLC fraudulently raised more than $8.8 million from 80 clients by falsely claiming they achieve consistent and outsized positive returns coupled with misrepresentations about the safety of the investments. Valente and the firm are challenging the accusation, so we only have the SEC’s view of the case.

The other view is the FINRA history. Broker Check can be controversial because brokers have a hard time fighting back against customer accusations. There is one brightline in BrokerCheck and Valente has it on his report. Valente is barred from association with any FINRA member. He was kicked out of the brokerage industry.

Apparently, he decided to switch over to “wealth creation and preservation”, instead of merely selling securities, and formed ELIV Group.

According to the ELIV website, it invests 40% of the assets into “initial public offerings.” But it then goes on to say to that “We are able to buy privately held companies before they go public at very low prices.” Well that does not sound like an IPO. That sounds live private equity or venture capital investing to me. But maybe I’m just being overly technical.

The second method is E-mini S&P 500 Futures. That’s a risky investment that requires constant trading, unlike the bread and butter S&P index funds and ETFs.

ELIV’s third method is options. Again, another volatile trading strategy.

The fourth strategy is currency trading, using seven currencies.

That’s a lot of trading and a lot of different areas of expertise. The website claims a five year average annual return of 34.5%. That’s a great result, especially considering that the firm has been around for less than five years.

Perhaps Mr. Valente can pull it off. However, the SEC says that Valente generated losses and stole money from his investors (? … clients?… victims?). The SEC claims that Mr. Valente withdrew over $2 million to pay his personal expenses, far in excess of the 1% management he was entitled to.

According to the SEC complaint at least some of the ELIV clients were Mr. Valente’s clients while he was a broker. There is the problem for consumers. How are they supposed to conduct diligence on a financial adviser when the securities laws, licensing requirements, and disclosure information sites are fractured into so many parts?

References:

Secure Borders

border insecurity

What do compliance and border security have in common? More than you might initially think. Try reading Sylvia Longmire’s Border Insecurity. Some of the issues with border security will resonate with compliance professionals. (Hopefully, you don’t have to deal with illegal immigration, human trafficking, terrorism and drug smuggling as the compliance issues at your company.)

One common problem is how you define success.

If there is a rise in the number of successful drug stops. Two things could be happening. You may have your rate of catching traffickers. Instead of finding 50% of the drug crossings, you are now finding 75%. Or there has been an increase in drug crossings and your success rate has stayed the same. It’s almost impossible to know.

The same is true with compliance. If there is a rise in the number of calls to the hotline, is it because more people are reporting, or because there are more incidents? It’s hard to measure success when the goal is prevention.

If the border were completely secure, there would be no apprehensions beyond the border and there would be 100% success in preventing illegal drugs from crossing border. Of course the border cannot be completely secure. Even if the entire length was securely double fenced, illegal crossing could go under the fences through tunnels, or over the fences with aircraft or catapults. (Yes, they really catapult drug packages over the fence.) Bad guys could move through legal crossings and possibly avoid detection. The World Trade Center terrorists came border checkpoints and not through clandestine crossings

Compliance can’t prevent bad things from happening. It can discourage the activity and it can try to detect the activity. Bad people will do bad things and try to get around the controls that prevent them.

There is ethics sprinkled in the book. Few doubt that the prevention of drug smuggling and criminals from crossing the border are very important elements of border security. Economic immigrants are a more nuanced discussion and Longmire does a great job discussing both sides. There is the humanitarian side and the economic side. Longmire’s approach is that it is a distraction. The limited border defense resources should be focused on the very bad things: drugs, criminals, and terrorists.

I found this book to be much better than Longmire’s first book Cartel. That book read like a collection of blog posts pasted together into a book. I received both books from the publisher with the expectation of a review.

Making Compliance Easier

easy

At PEI ‘s Private Fund Compliance Forum, one attendee asked how to make compliance easier. That caught the room by surprise. If compliance was easy, we would likely would not be at the Forum.

But it did get me thinking about ways to make compliance easier.

First, compliance is hard because the laws we comply with are complicated. Lots of the blame for difficulty can be pinned on Congress, the state legislatures and the regulators. The more complex the law, the harder the compliance.

The most obvious way to make compliance easier is to set simple rules. That may make it easier to comply, but more difficult for the organization.

Take political contributions as an example. For me, there is the SEC rule that limits investment adviser contributions. Layer on the state level requirement and you end up with a complicated list of what you can do and cannot do.

To make compliance easy, just ban all political contributions. Of course you run into the problem with the jurisdictions that prohibit a prohibition on political contributions. You also run into the problem of employees wanting to make political contributions. Your easy approach to compliance just got more complicated.

Or take the example of bribery and corruption. Your compliance policy could just ban all gifts and entertainment. But that leads to the awkward position of not even being able to buy a business prospect a cup of coffee as you are discussing an opportunity.

To make compliance easier, the organization and employees will need to sacrifice opportunities. The world is too competitive to sacrifice large swaths of opportunities that pose little or no risk to the organization.

That does not mean that compliance has to be hard in all areas of the business. You need to look at the risks and opportunities. Find the areas where you can make simple rules that don’t limit low-risk opportunities. Unfortunately, there are not that many.

Go back to my first point. The lawmakers and regulators keep making more and more rules. It’s rare to see a roll-back. As the laws grow, compliance requirements grow.