Month: November 2014

The SEC Shuts Down Another Illegal Crowdfunding Site

eureeca-logo

Kickstarter has shown the world that crowdfunding is a viable option for funding great ideas. Because of US securities laws, the funding arrangement on that platform cannot be for an equity interest. That’s selling securities and that practice is subject to decades of protections built to protect consumers.  The JOBS Act opened the possibility of equity crowdfunding sites for the masses, but the implementation is still hung up in SEC rulemaking.

That has not stopped internet entrepreneurs from firing up crowdfunding sites. There are ways to do so legally, but there are lots of regulatory and operational landmines that need to be navigated.

Of course, it’s very easy to set up an illegal crowdfunding site. Eureeca.com did that and subjected itself to the wrath of the SEC.

Eureeca.com’s approach was to make international investments available for crowdfunding. From looking at the funding proposals on the site, most seem to be coming out of the Middle East and North Africa. Since I see the proposals and can seemingly participate, Eureeca.com subjected itself to the jurisdiction of the SEC.

The website is a general solicitation for securities purchases. None of the securities are registered. Eureeca.com is not making any attempt to limit participants to accredited investors and is not taking steps to verify that investors are accredited investors. That would allow it to use the new Rule 506(c) exemption for public private placements.

The SEC wrath was a charge of failing to register as a broker-dealer.

According to the SEC order, three US investors put $20,000 into four offerings. That resulted in a $25,000 fine and new big disclaimer on the site:

The securities and services on the Eureeca platform are not being offered in the USA or to U.S. persons. For further information please read our FAQs.

If the offerings were in the US, the SEC would also be able to interfere with the private placements as violations, but the issuers are outside the reach of the SEC. I’m not familiar with the securities laws in the foreign jurisdictions, but I would guess that Eureeca.com is violating the securities laws in many other countries.

The SEC will continue to bring the hammer down on crowdfunding sites. The SEC worried about consumer protection and fraud in this area. I think they are right to concerned.

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Veterans Day – Remember Those Who Serve

veterans day 2014

Raymond Weeks of Birmingham, Alabama, organized a Veterans Day parade for that city on November 11, 1947, to honor all of America’s Veterans for their loyal service. Later, U.S. Representative Edward H. Rees of Kansas proposed legislation changing the name of Armistice Day to Veterans Day to honor all who have served in America’s Armed Forces.

In 1954, President Dwight D. Eisenhower signed a bill proclaiming November 11th as Veterans Day and called upon Americans everywhere to rededicate themselves to the cause of peace. He issued a Presidential Order directing the head of the Veterans Administration, now the Department of Veterans Affairs, to form a Veterans Day National Committee to organize and oversee the national observance of Veterans Day.

Take a few minutes today to remember those who served.

Weekend Reading: The Map Thief

map thief

The classic business edict is to buy low and sell high. E. Forbes Smiley took that edict to heart in his business as an antique map dealer. Unfortunately, he discovered he could get his cost close to $0 if he stole his inventory. Michael Blanding captures the story of Mr. Smiley and the world of antique maps in The Map Thief: The Gripping Story of an Esteemed Rare-Map Dealer Who Made Millions Stealing Priceless Maps.

It turns out that valuable maps are much easier to steal than art. Works of art are generally one-of-a-kind pieces that hang in museums where everyone knows where they are. It’s hard for thieves to break and in and steal one. It’s even harder to try and sell the unique, identifiable, and now-known as stolen item.

In contrast, rare maps may be printed in thousands of copies, of which some unknown quantity may have survived over the centuries. They are rare, but not necessarily unique.

It also turns out that libraries are chock full of old map collections and atlases that are poorly cataloged, poorly tracked, and poorly monitored.  Mr. Smiley discovered that he could greatly increase his profits by attacking one of these libraries. He would pocket a map from a messy collection or tear maps from their bindings in atlases.

One of Mr. Smiley’s client was Norman Leventhal, the patriarch of the firm that employees me. The walls of my offices are adorned with part of his collection.

You can see the lack of controls at the libraries. One result of Mr. Smiley’s capture was an increased emphasis on libraries tracking their map collections. Mr. Smiley was not the only thief among map dealers.

The one weakness in the book is what made Mr. Smiley turn from respectable map dealer to thief. There is some discussion of his finances and a possible need to for more cash. There is also an implication that felt left out when one of clients made a large donation to a library. Mr. Smiley thought he was entitled to more. But it seems like the thievery started before then.

In the end we just don’t know what caused him to step over the line.

 

Compliance Bricks and Mortar for November 7

rainbow bricks

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

Fordham Law offers LL.M in Corporate Compliance, expands JD training by Sean J. Griffith in the FCPA Blog

The new compliance programs are good news for law students. According to The Wall Street Journal, starting salaries for compliance officers have been rising 3.5% each year since 2011. Moreover, those officers with a law degree are generally in a better position to advance to the higher end of the pay scale. In some large companies this salary may figure at more than $200,000.

Compliance Professionals Getting Grief by Roy Snell in SCCE’s Compliance & Ethics Blog

On occasion I get a little grief for being in the compliance profession. Sometimes it’s misguided because they think compliance professionals make up all the rules and they don’t like rules. But it’s still tiresome.

On Fifth Anniversary Of Rothstein’s $1.2 Billion Ponzi Scheme, Questions Remain by Jordan D. Maglich in Ponzitracker

Five years ago on a late October night, prominent lawyer Scott Rothstein hurried down an empty tarmac towards a waiting Gulfstream plane bound for Morocco – a country that lacked an extradition agreement with the United States. Rothstein’s once-extravagant lifestyle was collapsing before his eyes, with hundreds of investors soon to learn that Rothstein had masterminded a massive $1.2 billion Ponzi scheme. Carrying a duffel bag stuffed with over $500,000 and with $16 million sitting in a Moroccan bank account, Rothstein had little intention of returning to the U.S. to face the music.

Gallagher: Dodd-Frank Has SEC ‘Shoveling Manure’ for ‘No Discernible Purpose’ by Bruce Carton in Compliance Week

In his latest attack on the law he recently called “Dodd-Frankenstein,” SEC Commissioner Daniel S. Gallagher stated that the Dodd-Frank Act has left the Commission spending “much, if not most, of its time and resources for nearly half a decade shoveling manure, in some cases for no discernible purpose whatsoever.”

 

 

Rainbow Bricks by fusion-of-horizons

LinkedIn and Compliance for Private Funds

LinkedIn-Logo

At the recent  I was talking with another attendee about LinkedIn and the SEC rules on advertising. The basic question was can her employees use it. That became a more nuanced discussion of the various features.

One topic was the messaging feature of LinkedIn. You can send massages to people on LinkedIn. It’s not a great tool, but some people like it. Her interest was because some of her employees wanted to use it to communicate with clients and potential clients. That was the first red flag.

As a registered investment adviser, her firm was subject to the record-keeping rules. Rule 204-2(a) (7) requires an investment adviser to keep records of certain communications between the adviser and its clients. If the communication is happening on a third-party platform, it’s outside of the investment adviser’s reach. That means getting a third-party application to capture that communication. There are several vendors who claim to be able to do so. ( Smarsh is one. Global Relay is another. )

The other question that I, and those nearby, latched onto was the “testimonials” implication of LinkedIn.

The advertising limits under Rule 206(4)-1 limit the use of any communications “which refers, directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, anaylsis, report or other service rendered by such investment adviser.” LinkedIn has several features that could be considered a testimonial.

The first is the recommendation feature. If a client writes a recommendation of the investment adviser, you’ve violated the rule. A recommendation would be considered a testimonial. The SEC’s view is that a testimonial may not represent the experience of a typical client. You can agree or disagree with the rule, but the rule is still in effect. My opinion was to have her employees shut off the recommendations feature and not allow them to use it.

The other feature that raises concern is the skills and expertise feature. That allows your connections to endorse particular skills. I personally find this feature to be wonky. The list of skills and expertise that I see in my profile seem a bit random and off base. Although some are right on target.

If a connection endorses a skill and expertise, I think that is a testimonial. Given that the endorsement could be from a client, then publishing that endorsement would violate the advertising rule’s ban on testimonials. My recommendation was to ban use of that feature.

What are your thoughts on the use of LinkedIn?

 

Post – Election Day Now What?

Im-just-a-bill -schoolhouse rocks

Now that the Republicans have taken control of Congress, can we expect changes that will affect the private fund industry? Many of the Republican firebrands that now run the legislative process in both houses have spoken about repealing the Dodd-Frank Wall Street Reform and Consumer Protection Act.

A wholesale repeal of Dodd-Frank is highly unlikely. Such a bill would be vetoed by the President and the Republicans do not have the numbers to overturn a veto.

Of course Congress may still pass a repeal bill anyhow. After all, the Republican controlled House has passed a bill repealing the Affordable Care Act dozens of times over the past few years, knowing that it will never pass the Senate or the President’s veto.

A more sensible Republican strategy will be to package some changes to Dodd-Frank in a cleverly marketed bill. We saw that happen with the JOBS Act.

Congress does have control of spending, so it’s unlikely that the Securities and Exchange Commission will be getting big budget increases.

The Volcker Rule is prime candidate for changes. Although, it is a simple idea, it has been notoriously difficult to design and implement.

I would place my bets on investment adviser user fees and a Self-Regulatory Organization to regulate and enforce investment advisers. It accomplishes more oversight that is likely to favored by the Democrats and takes resources away from the Securities and Exchange Commission that is likely to be favored by Republicans.

That is assuming that there will anything other than legislative gridlock and positioning of candidates for the 2016 presidential election.

Vote!

vote

The United States fought hard for a constitutional democracy, but came short by initially limiting the vote to white men. It’s been the voting since then that has resulted in a broader section of the population having the right to vote.

Exercise that right.

You may not like any of the candidates, but you should still make the trip to the polls and vote for the one you dislike least.

Custody Rule Enforcement

SEC Seal 2

The Securities and Exchange Commission has been pointing out custody issues for investment advisers, made it an exam priority for 2014, highlighted in its presence exam initiative, and highlighted it in its never before examined initiative. So it should come as no surprise that the SEC brought an enforcement case solely for custody rule violations.

The SEC brought charges against Sands Brothers Asset Management LLC, its co-founders Steven Sands and Martin Sands and its chief compliance officer and chief operating officer Christopher Kelly. They are contesting the charges, and we don’t have they’re side of the story.

I think you should pay attention to what the SEC highlighted in the press release as the violations:

According to the SEC’s order instituting an administrative proceeding, Sands Brothers was at least 40 days late in distributing audited financial statements to investors in 10 private funds for fiscal year 2010.  The next year, audited financial statements for those same funds were delivered anywhere from six months to eight months late.  The same materials for fiscal year 2012 were distributed to investors approximately three months late.

The SEC is pointing out very technical violations. Since it’s a 206 violation, the SEC does not have to allege intent to defraud or investor harm. Technical violations are enough.

Behind the scenes, the SEC is alleging more bad actions. According to the SEC’s order, Sands Brothers and the two co-founders were previously sanctioned by the SEC in 2010 for custody rule violations. One of the top things to do when getting a bad mark from the SEC is to fix the problem. The Sands knew there was a problem and apparently continued to violate the custody rule.

Private fund managers can comply with some aspects of the custody rule by distributing audited financial statements to fund investors within 120 days of the end of the fiscal year. That is generally an easy standard because most private funds are required to deliver audited financial statements to investors each year within that time frame. As much as a fund manager does not want to violate an SEC rule, a fund manager does not want to intentionally violate its explicit obligations under its partnership agreement.

The tougher part of the custody rule for fund managers is older, legacy funds and parallel funds that are not required to be audited and the investors do not want to pay for an audit.

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