Month: October 2014

Lawsuit on SEC’s Political Contribution Rule Hits Some Snags

USDC for DC Meade_and_Prettyman_Courthouse

The New York Republican State Committee and the Tennessee Republican Party brought suit against the Securities and Exchange Commission challenging its political contributions rule for investment advisers, . The complaint seeks an injunction against the enforcement of the rule’s political contribution restrictions on contributions to federal candidates.

The US District Court for the District of Columbia dismissed the case. But not all is lost in Mudville. The decision hinged on whether the District Court or the Court of Appeals should have jurisdiction over the case.

The District Court found that the political contributions rule is an “order” for purposes of the Investment Advisers Act. That means the proper venue is the Court of Appeals. That means that the New York Republican State Committee and the Tennessee Republican Party merely have to refile the case in the Court of Appeals.

However, the District Court raised the issue of standing that may come to haunt the New York Republican State Committee and the Tennessee Republican Party. As political organizations, they are not directly affected by the rule. It’s really the candidates and the regulated advisers who are hurt by the rule. The party organizations failed to allege any specific facts that show a decline in contributions because of the political contributions rule.

The party organizations did point to State Senator Lee Zeldin, a candidate for the U.S. House of Representatives as an individual who was harmed by the rule.

I thought this would be a tough case to win on the merits. It may never get to the merits because of the jurisdiction and standing issues.

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The SEC Still Hates Intrastate Crowdfunding

Icon of Money in the Hand on Rusty Warning Sign.

One of the exemptions from registering a securities offering is if the offering is limited to one state. Some crowdfunding advocates latched onto this exemption and have been pushing for single state crowdfunding at the state legislatures. On April 10, 2014, the SEC issued a Compliance and Disclosure Interpretation on intrastate crowdfunding offerings. The interpretation was overly restrictive.

The SEC said at the time that you can’t use a third-party portal website for an intrastate securities offerings. “Use of the Internet would not be incompatible with a claim of exemption under Rule 147 if the portal implements adequate measures so that offers of securities are made only to persons resident in the relevant state or territory.” In reading that, the SEC waved a big regulatory “NO” finger at using third party sites.

The SEC just retreated slightly from that position, but proved that the SEC does not understand how the internet works. In Question 141.05, published on October 2, the SEC seems to be a bit more lenient when it comes a company using its own website. The SEC acknowledges that a website advertises the company, but could also advertise a securities offering. “Although whether a particular communication is an “offer” of securities will depend on all of the facts and circumstances…”

If the company does make the existence of an investment opportunity available on an unrestricted website, that could be considered a violation of the intrastate exemption. The SEC offers up the solution that a company “could implement technological measures to limit communications that are offers only to those persons whose Internet Protocol, or IP, address originates from a particular state or territory and prevent any offers to be made to persons whose IP address originates in other states or territories. ”

The location of an IP address does not necessarily equate to your state of residence.  It may not even equate to where you at the moment you are accessing the internet. One of the great values of the internet is that is defies and defeats physical borders.

 The SEC’s solution is short-sighted and poorly thought out.

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More Findings on SEC Exams of Private Funds

bowden

Andrew Bowden unloaded a truckload of information at the recent CFA Institute in Boston. Andrew Bowden is the Director of the U.S. Securities and Exchange Commission’s Office of Compliance Inspections and Examinations. His comments were based on audience questions, instead of a prepared speech. You can’t find it on the SEC website, but you can watch it at the CFA Institute’s website.

Of the 1,500 private fund advisers that registered because of Dodd-Frank, the SEC set out to examine roughly 25 percent of these firms by the end of 2014. According to Bowden, 370 firms have been examined, and OCIE is on track to reach 400 by the end of the year. Half of those are hedge fund managers and half are private equity fund managers.

Bowden noted his May speech on fees and expenses at private equity funds.

He said the deficiencies for hedge funds largely fell into three main categories: Custody, valuation, and marketing/advertising. On the positive side, he found hedge funds to be doing a generally good job on compliance. The marketplace of institutional investors demanded it.

(The contrarian in me will argue that SEC examiners merely better understand hedge funds than private equity funds.)

The custody-related deficiencies were mostly technical in nature. For example, the hedge fund may have an account that was not subject to an audit.

Regarding valuation, the SEC found that some firms were switching their valuation methodology from period to period to achieve the highest possible investment valuation.

For the marketing-related deficiencies, the SEC examinations discovered that most of failures were mostly technical failures under the SEC rules. Some of that can be chalked up to moving from pre-registration materials to post-registration requirements. In some cases, hypothetical and/or back-tested performance was being represented as actual performance, portability situations were being improperly documented and disclosed, and inappropriate benchmarks were being used. He focused that false claims of compliance with GIPS is a material misrepresentation. He also used the Bitran case as an example of false performance advertising.

Bowden also highlighted the SEC’s new national exam analytics tool, which allows its examiners to rapidly analyze trade data.

“Three years ago, an SEC examiner would go into a firm and ask to see its trade blotter for the past two weeks or month, put it into Excel, sort it into columns, and try to spot signs of cherry picking, front running and insider trading,” he said. “The quants developed a tool that allows examiners to see the trade blotter for three years as a standard practice and subject that to more than 50 tests.”

He also highlighted the never-before examined initiative. That has reached about a significant chunk of the 20% of the firms registered for 3 years that had never before been examined. He also noted that several regional offices are calling new firms as they register for an hour long call.

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Weekend Reading: Attachments

attachments

For those compliance officers who do email surveillance, you should enjoy the premise of Attachments by Rainbow Rowell. Lincoln, the protagonist is responsible for email surveillance. He falls for one employee who is a repeat offender whose emails routinely get flagged for his review. He falls in love, but has no idea what she looks like.

I’ll admit that it was the premise that caught my attention. You have to wonder if those hours spent reviewing emails could lead to something else. Rowell takes that premise and has fun with it.