Month: September 2014

Compliance Bricks and Mortar for September 12

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

Let’s Get This Straight, A URL Is Not An Address (At Least In This Case) by Keith Paul Bishop in California Corporate and Securities Law

The tenant argued that the notice was defective because it included a URL (uniform resource locator) address rather than the address of a physical location. The Appellate Division agreed, finding that the correlation of the address to a person in the statute “indicates that the ‘address’ which is intended is a physical address where that person can be found to receive rent payment, and not a string of characters identifying the location of a website.”

Students Required to Learn Business Fundamentals at Boston University School of Law

Boston University School of Law will now require all JD students to complete a foundational course in business literacy, Introduction to Business Fundamentals, beginning with the Class of 2017. The course offers instruction in business, financial accounting, corporate finance and related concepts, while the format—an asynchronous, online series of one-hour modules—allows students to approach each concept at an individual pace, based on their familiarity with the topic.

SEC Announces Creation of New Office Within its Division of Economic and Risk Analysis

The Securities and Exchange Commission today announced the creation of a new office within the Division of Economic and Risk Analysis (DERA) that will coordinate efforts to provide data-driven risk assessment tools and models to support a wide range of SEC activities.

Pension Funds Sue Stock Exchanges Over High-Frequency Trading by Scott Patterson in WSJ.com’s Law Blog

The complaint, filed Sept. 2, alleges stock exchanges provided high-frequency firms “enhanced trading information at faster speeds” than other investors received. The exchanges also crafted “complex order types” that gave sophisticated traders advantages, such as the ability to trade in front of other investors to get a better price.

9 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 2,977 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. One was an employee of my company.

Make a few minutes today to remember those 2,977 lives lost directly, and the thousands more as a result of the subsequent military actions. Thousands more Americans were killed in Afghanistan to attack the perpetrators of 9-11.

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 come from terrorism. 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 9-11 attacks. Think about how the Ferguson police force ended up with those tanks and surplus military equipment.

The SEC Is Serious About Section 16 Filings

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Section 16(a) of the Exchange Act and the rules promulgated thereunder apply to every person who is the beneficial owner of more than 10% of any class of any equity security of a public company, and any officer or director of a public company. The Securities and Exchange Commission announced a sweeping group of charges against 34 officers, directors and major shareholders for failing to make their section 16 reports.

Apparently, the SEC had an initiative underway to review filing deficiencies and identified individuals and companies with especially high rates of filing deficiencies. These ownership reports can give investors the opportunity to evaluate whether the holdings and transactions of company insiders could be indicative of the company’s future prospects.

Andrew M. Calamari, Director of the SEC’s New York Regional Office, added, “The reporting requirements in the federal securities laws are not mere suggestions, they are legal obligations that must be obeyed.  Those who fail to do so run the risk of facing an SEC enforcement action.”

Clearly, the SEC is making  a statement by announcing these 34 sets of charges. (33 of the 34 have already agreed to settle.) Time to review filings if you are subject to these reporting requirements.

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Do You Need to Know Enforcement Cases for Compliance?

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Are you familiar with SEC investigations pertaining to the following companies?

  1. Aladdin Capital
  2. Diamondback Capital
  3. Liquidnet
  4. Paradigm Capital
  5. SAC Capital
  6. Galleon Capital

I admit that I only recognized SAC Capital and Galleon Capital. In a recent survey about half of alternative investment managers said that they were also familiar with those two cases. Half said they were not familiar with any of them.

Private Equity International pointed out this survey by Cipperman Compliance Services. Cipperman cited unfamiliarity with the cases as a indicator of adequate resources to address increased regulatory obligations.

I scratched my head a bit to figure out if I missed the cases or merely didn’t link the substance of the case with the firm name.

I searched the Compliance Building website to see if had mentioned the four cases.

It turns out that I wrote about Paradigm Capital in June 2014. The substance of the case was a whistleblower claim by a trader against his firm, Paradigm Capital. The firm was engaged in some principal trades that were violating 206(3)-2. The trader reported the problem to the SEC and the firm handled it poorly.

I also wrote about the Aladdin case in December 2012. It involved a false claim by the fund manager that its principals were investing in the fund alongside investors. I don’t remember the case being particularly remarkable. They were lying to investors.

Diamondback Capital was linked to SAC Capital and was allegedly involved in insider trading. The firm settled by paying a fine and entering into a non-prosecution agreement. The firm ultimately returned investor’s capital and dissolved. This was one of the expert network abuse cases. I remember the expert network investigations and still get questions from investors about the use of expert networks. I remember the issue, but not the case.

Liquidnet is a dark pool high speed trading case. The exchange settled the charges that it allowed outside traders to have access to the trading inside the dark pool. It’s an interesting look into the complex world of high-speed trading and dark pools. I don’t remember the case.

Circling back to the original question, I’m not sure knowing the case name is particularly necessary to understand compliance concerns. I find cases to be instructive on what is found to be bad acts. That’s why I write about them.

Yes, it’s a good thing for compliance officers to read the SEC’s enforcement actions. But I don’t think you need to be quizzed on cases.

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Combining Immigration Fraud and Investment Fraud

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The EB-5 Immigrant Investor Program sounds like a scam so I’m not surprised to see it pop up in actual scams. The EB-5 program provides foreign investors who can demonstrate that their investments are creating jobs in this country with an expedited path to lawful permanent residency in the United States. EB-5 is not common with real estate investors because construction does not provide the permanent jobs required by the program. (The exception is hotels.)

The Securities and Exchange Commission brought charges against Justin Moongyu, Rebecca Taewon Lee and Thomas Edward Kent for combining an EB-5 program with an investment scam. The three raised $11.5 million for investment in a Ulysses, Kansas ethanol production plant. According to the SEC complaint the three were promoting a positive investment return coupled with a path to legal residency in the United States.

The SEC alleges that the three diverted over $7 million of the investor’s money to unrelated projects and personal use. The plant was never built.

As you might expect, the SEC complaint spends a chunk of the pleading showing that the fraud involves securities. The SEC states a case that (1) there was investment of money, (2) there was a common enterprise, and (3) profits were to be derived from the efforts of others.

Although it’s not clear from the case filings, I assume the investors not only lost their money, but also lost their path to citizenship.

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USA-NYC-Ellis Island
CC BY-SA 3.0

By: Ingfbruno

 

Compliance Bricks and Mortar for September 5

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

Fantasy Football: A Real and Present Danger to the Workplace? by Daniel Schwartz in Connecticut Employment Law Blog

So to answer my own question in the title: No, fantasy football is not a critical threat to your business. But sometimes, fantasy football can be used support a claim of harassment or discrimination.

Fantasy football, despite its name, is a real industry and those companies that treat it as mere child’s play, do so at their own risk.

Pro Football and the FCPA Professor by Tom Fox in the FCPA Compliance and Ethics Blog

In football players certainly want to play hard but face penalties for playing too aggressively. I would add that sometimes there are grey areas in the rules that can get players into trouble. Moreover, just as each football team will have its own risk tolerance, businesses will as well. The Professor states, “The same is true for FCPA compliance. Business organizations, particularly those accountable to shareholders to increase value, should aggressively compete in the global marketplace to gain a competitive edge over competitors. Yet the practical reality is that much of what happens in the global marketplace can also fall into a gray area given the FCPA’s provisions, which have frequently been found to be vague and ambiguous when subjected to judicial scrutiny.

For Hedge Fund Whistleblower, Waiting Was the Hardest Part by Lillian Rizzo in WSJ.com’s Risk and Compliance Journal

When Frank Harrison decided in 2009 to go to the Federal Bureau of Investigation with allegations of fraud at hedge fund New Stream Capital LLC, he wasn’t prepared for one of the most nerve-wrecking aspects of being an informant—a long wait with little inkling of action being taken

The FBI’s Interesting Endgame with Michael Lucarelli by Bruce Carton in Compliance Week

Based on his trading patterns related to other client information, the FBI anticipated that Lucarelli might trade based on the Trex information. Indeed, a few days after the search, Lucarelli did purchase shares of Trex, and allegedly made nearly $90,000 in illegal profits when he sold the stock after the public disclosure of Trex’s improved sales and income caused its stock price to increase nearly 15%.

The SEC Brings Another Case Centered on the EB-5 Immigration Program by Thomas O. Gorman in SEC Actions

The government’s EB-5 program is supposed to be a win win for everyone. For immigrants seeking admission to the United States it is supposed to provide a path to citizenship if the requirements, centered on the investment of $500,000 or more in select projects, are met. For the U.S. it is a job creation mechanism since the investments from those seeking admission under the program, administered by the United States Citizenship and Immigration Service, are supposed to be used to create jobs in this country. Unfortunately the program is now at the center of yet another SEC enforcement action and a parallel criminal case. SEC v. Lee, Civil Action No. 2:14-cv-06865 (C.D. Cal. Filed September 3, 2014).

What Does Delaware’s Wal-Mart Decision Mean for the Attorney-Client Privilege and Internal Investigations? by Chip Phinney in Mintz Levin’s Securities Litigation and Compliance

In some respects the Wal-Mart decision is disconcerting for corporate counsel. It suggests that counsel conducting internal investigations of allegations of corporate wrongdoing should bear in mind the possibility that someday their privileged communications, which they assume to be confidential, may be subject to review by a shareholder plaintiff’s counsel seeking grounds to sue the corporation’s directors and officers. But the Walmart case involved unusual circumstances and should not be read as opening privileged communications by corporate counsel to widespread discovery in most shareholder litigation.

Failing to Disclose Fees

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The Securities and Exchange Commission has been focused on fees charged by investment advisers and fund managers. The latest target is Robare Group Ltd. based in Houston. The SEC alleges that the firm was receiving a fee from certain investments made for its clients but failed to properly disclose that it was receiving the fee.

According to the SEC order, an unnamed broker agreed to pay the Robare Group a fee for client funds invested in funds sold by the broker. There is nothing inherently wrong with that arrangement. However, it should be disclosed to clients. The concern is that the adviser would direct clients to invest in those funds because it is good for the adviser, not necessarily because it is good for the client.

One interesting thing about the alleged violation is that the SEC is not stating any harm to Robare Group’s clients or even that the clients were invested in the fund for a disproportionate amount. The SEC is focused solely on a violation for failure to disclose. The disclosures were not adequate because they said the Robare Group “may” receive compensation from the broker for selling the mutual funds, when it was definitely receiving payments, the SEC said. In my opinion, that’s a very thin distinction to make.

The interesting thing about the press release for the alleged violation is the statement that the SEC’s asset management unit has enforcement initiative focused on undisclosed compensation arrangements between investment advisers and brokers. This is sounds like a similar effort focused on undisclosed compensation to private equity fund managers from portfolio companies.

 

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How Does the SEC Use Form PF in Adviser Exams?

Form PF

You slave over Form PF trying to get the information demanded by the Securities and Exchange Commission. What happens to that data?

The Dodd-Frank Wall Street Reform and Consumer Protection Act Section 404 directed the SEC to establish reporting requirements for investment advisers to private funds as necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk by the Financial Stability Oversight Council. Form PF was the result of Section 404. That section of Dodd-Frank also requires the SEC to submit an annual report to Congress on how the SEC is using the data.

According to the latest annual report, the SEC uses Form PF data in its examination and enforcement programs.

Prior to an examination of a private fund adviser that files Form PF, OCIE staff generally reviews the adviser’s Form PF filing as a part of a routine pre-examination evaluation. This review, in conjunction with other data sources, provides OCIE staff with an understanding of the nature of an adviser’s business and investment strategy.

I did not find this to be the case. The Form PF data is locked away from OCIE and examiners need permission to access the data. At least that was the case in the Boston office six months ago.

It’s good that potentially sensitive data is hard to access. That was supposed to be the case with Form PF data. Examiners are already deep into a fund manager’s business operations do the Form PF data would not likely contain any secrets that the examiners are not already looking at.

The examiners will compare the Form PF data to what shows up in due diligence reports, pitch books, offering documents, operating agreements and books and records. Exam staff will look for discrepancies between an adviser’s Form PF filing and any publicly-available documents related to the adviser, including Form ADV.

According to the report, the SEC is collecting Form PF data on 21,542 funds. Of those, 2,888 are large private equity fund advisers (over $2 billion in RAUM) of a pool of 7,004 private equity funds. There are 1,397 real estate funds reporting with $354 billion in RAUM.

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