Month: December 2015

Jedi Training and Compliance Training

As I was gently caressing my tickets for tonight’s early premier of Star War: The Force Awakens, another compliance thought came to mind. The Star Wars saga shows three examples of Jedi training. One of which falls far short of the compliance standard.

yoda

We see glimpses of the younglings training at the Jedi Temple. That was the standard method at the time, giving their plastic young minds the right message from early on. We don’t know how well the training went because Anakin slaughtered them in Episode III.

In Episode V, we see Yoda’s training of Luke in the swamps of Dagobah. That seems to work, even though the training seem incomplete. At the end of Episode VI, Luke is tempted by the Emperor to come to the Dark Side. Doing so will save his friends. Luke is tempted, but does not cross the line.

We see Obi-Wan Kenobi’s training of Anakin Skywalker in Episodes II and III. Young Anakin was already too old for the Jedi Council’s standards, but they relented to Obi Wan’s plea to take Anakin under his wing.

He is beloved as a character, but Obi Wan falls short in compliance training.

He pushed the Jedi Council to break its rules and allow Anakin to begin training. As we see in Episode III, he was too old and had become too attached to his mother.

The one key to Jedi training is to avoid the Dark Side. Obi-Wan failed to see the signs and put Anakin into remedial training.  Anakin is tempted to the Dark Side and crosses the line.

The key goal to compliance training is teaching employees where the line of good and bad is and to stay away from the line. The employee may perform well or not, but you don’t want the employee to cross the line to the dark side.

Obi Wan was lured by the prospect that Anakin was supposed to be the “chosen one,” restoring balance to the Force. He broke the rules to get him into Jedi training. He overlooked Anakin’s shortcomings and misteps because he thought he was the “chosen one.”  In the end, the training failures lead to the destruction of the Jedi, the rise of the Galactic Empire and the loss of millions of lives.

The Compliance Failure of the Death Star

The Death Star was touted as the “ultimate power in the universe.” But a few proton torpedoes managed to destroy the entire station. It didn’t make into the trilogy, but I assume there would have been an ensuing investigation that would have looked at the failures that lead to loss. At least I imagined there must have been while my family was re-watching the Star Wars movies in anticipation of this week’s premiere of Episode VII.

death star

The entire series starts with Darth Vader pursuing Leia Organa because she has gotten her hands on the technical readouts for the Death Star. If the Empire was so sure that the battle station was invincible, it would not have been so concerned. At least you would think so. But perhaps it’s just a plot device.

Grand Moff Tarkin, who had overseen the construction of the Death Star, dismisses the idea that the moon-sized battle station is at risk from an attack by small fighters. He is right. The risk is very small. It was a small, shielded exhaust port. he shot “was impossible, even for a computer.”

The first attack run resulted in the destruction of the fighters. The second attack run hit the target but merely impacted on the surface. It is only the Luke Skywalker with his Force assisted attack that manages to hit the difficult target correctly. T

Of course the outcome is catastrophic so there was clearly a mistake in the design of the station.

The Emperor was not happy and began a culling at the highest ranks of the Empire, executing officials such as Moff Coovern and Minister Khemt, believing that their incompetence was partly to blame for the station’s annihilation. That does not sound like great way to run a “lessons learned” post-action review.

We don’t know if the design was improved for the Death Star II. It too was destroyed, but under different circumstances. It was, in part, constructed as trap to destroy the Rebel Alliance. The Emperor left it appearing vulnerable, when it was in fact fully operational, with the a huge portion of the Imperial Fleet hidden nearby. The flaw was in the Emperor’s plan by overlooking the capabilities of the local Ewoks.

In the end, I say it was not a compliance failure, it was a governance failure. The Emperor ran his organization through fear, using Darth Vader to intimidate of kill those dared question the Emperor. Grand Moff Tarkin executed the Emperor’s orders, creating a massive battle station that could destroy planets and star cruisers. But they overlooked the small things. And that lead to their downfall.

I don’t think the Emperor would have tolerated a compliance program. Unless you view Darth Vader as the CCO.

It was the arrogance of the top leadership failed to see the risks and thought they could see everything, unaware of their blind spots.

If you want more Star Wars and compliance mash-ups, check out Tom Fox’s posts this week:

The Jedi and Compliance Failures

My family has been re-watching the Star Wars movies in anticipation of this week’s premiere of Episode VII. While watching Episodes I-III, I wondered if the Jedi could have used some compliance strategies to help prevent their downfall.

come to the dark side we have cookies

Two of the goals of compliance are (1) to deter people in your organization from doing bad things and (2) to identify a fed flag that could indicate something bad has happened or is about to happen.

Obviously, going to the dark side is a bad thing. You can tell, because they wear black. The Jedi needed to takes steps to prevent its members from being tempted by the power of the dark side of the force.

The obvious first steps in compliance are periodic certifications:

  • I have not been tempted by the dark side this quarter.
  • I am not interested in galactic domination
  • I am not experiencing any of negative emotions: fear, anger, hatred and rage
  • I am not in a romantic relationship

I suppose having Mace Windu sit down and fill out a form would be kind of silly.But it could be a deterrent.

The Jedi Master seem to able to detect variations in the force.Maybe a periodic review with the Jedi Council would be a good way to see if anyone is being tempted by the dark side.

The Jedi knew that Anakin Skywalker was having troubles. He was at risk of being a rogue Jedi.

The Jedi Council had a compliance failure form the beginning. Young Anakin was older than what was allowed by the Jedi code to become a padawan and begin Jedi training. The Jedi violated their own policies and procedures.

The Jedi Council failed to take actions to discipline Mr. Skywalker. They  saw his small digressions, but took no actions to discipline him for his mistakes.

The result was a rogue member of the organization destroyed the entire organization. In this case, that also meant dissolving the Galactic Senate, the rise of an evil galactic empire and the loss of billions of lives.

Maybe a Jedi compliance warrior could have helped prevent the downfall.

If you want more Star Wars and compliance mash-ups, check out Tom Fox’s posts this week:

If you like the image at the beginning, you can get it on a T-Shirt at Woot!. (My son has one.)

Do As I Say, Not As I Do

As financial firms are the recipients of more and more reporting obligations from government regulators, I find it amusing to note when the lawmakers fail in their own reporting obligations. The Wall Street Journal is reporting that Senator Bob Corker failed to disclose millions of dollars in his financial reports.

senator bob corker

The senator is the third-ranking Republican on the Senate Banking Committee, which oversees the real-estate and financial-services sectors. This is the committee that oversees the Securities and Exchange Commission and is, at least in part, the architect of the reporting obligations of fund managers and investment advisers.

“I am extremely disappointed in the filing errors that were made in earlier financial disclosure reports,” Mr. Corker said in a statement to the Wall Street Journal.

I don’t think the SEC would be as receptive to that statement when made during an examination.

Or for blaming the accountants for using the wrong method.

I’m not accusing the Senator for any wrongdoing. He relies on his team of advisers to follow the rules imposed on him.

Of course the same can be said for many investment advisers. Do As I Say, Not As I Do

Sources:

Compliance Bricks and Mortar for December 11

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

merry christmas brick

A Compliance Plan or a Compliance Idea? by John Nocero in SCCE’s The Compliance & Ethics Blog

Much of what we do is dictated by our compliance plan. But we also need to be able to react based on arising risks or incidental findings. Often, being able to reprioritize is most important. I write a goal list of what I am going to get done each week, but some weeks are impossible to predict. You often need to make changes in real-time. Very rarely you can ever say you are totally locked in to a particular plan. Maybe it is better to characterize the compliance plan as a compliance idea – you are pointed in the right direction, but you are ready to make an adjustment if needed. [More…]

GP charged for failing to disclose portfolio company loans By: Katherine Bucaccio in Private Funds Management

The US Securities and Exchange Commission (SEC) has charged San Francisco-based private equity firm JH Partners for failing to disclose loans that the firm made to its portfolio companies, according to an SEC order filed at the end of last month.

The SEC claims that JH Partners and some of its principals provided approximately $62 million in direct loans to portfolio companies across three of its funds from 2006 to 2012. Through the loans, the firm acquired interests in the portfolio companies that were senior to the equity interests held by the funds, however, JH Partners did not disclose the loans or the potential conflict of interest to its LPs. [More…]

Unfair & Unbalanced Podcast with Tom Fox & Roy Snell – Episode #1

Taped at SCCE’s 2015 Compliance & Ethics Institute at the ARIA in Las Vegas. In this first episode, noted FCPA lawyer and blogger Tom Fox, and Society of Corporate Compliance & Ethics CEO, Roy Snell, discuss the importance of an independent compliance officer, misconceptions about compliance in general (hint: it’s not that hard), updating the Federal Sentencing Guidelines, the most important word in the Yates Memo, and some of the immediate effects of the Volkswagen scandal. [More…]

Brick in front of Belly Timber by Eli Christman
CC BY

The State of CCO Enforcement Actions

I was at the IA Watch conference titled “Coping with Regulatory Change” and several presenters from the Securities and Exchange Commission in different panels took a fair amount of time saying that the SEC is not targeting CCOs for enforcement actions. This was in light of several SEC actions against compliance officers in the last few years.

failure

The SEC party line is that it will defer to the good-faith determinations of the CCOs. Of course, CCOs are not granted immunity from enforcement actions. The SEC has put for the three categories for when CCOs are subject to actions by the SEC.

1.  Participating in the wrongdoing

The first area of liability is when the compliance officer is participating in the wrongdoing. This is an obvious area of liability. Compliance title is not an absolute shield.

There was the Yue Han case in last few weeks where a compliance associate at Goldman Sachs was accused of trading on inside information on pending deals. He found the inside information while conducting email surveillance in his compliance role.

2. Hindering the SEC examination or investigation

The second area is not doing the bad acts, but effectively helping to cover them up.Lying to the SEC or submitting knowingly false documents is known area liability.

The example is the Wells Fargo case. Judy Wolf was a compliance professional at the firm. When an SEC investigation in insider trading came to light, Ms. Wolf went back and altered the documents around her own review of the particular trades.

Even though this was an enforcement action, the SEC administrative law judge dismissed the action this last August.

3. Wholesale failure

The third are of liability is when there is a “wholesale failure” by the compliance officer.  This level of failure seems to be a high standard, but the recent SEC actions makes me wonder how high that standard is. It doesn’t seem to be as such a high bar as you might think.

Shortly after the conference a new action was released that included separate charges against the CCO. The Sands Brothers case involved repeated violations of the custody rule. After SEC deficiency letters and a prior enforcement action, the firm continued to fail to deliver audited financial statements as required by the custody rule. Surely a failure.

“Wholesale failure”? Sure. I would not want to defend the CCO by saying it was not a wholesale failure. Sadly, the order did not use this term.

The SEC has been inconsistent with its interpretation of the “wholesale failure” of the CCO. In the BlackRock case, the CCO was blamed for inadequate policies and procedures.

The SEC’s order found that BlackRock and its then-chief compliance officer Bartholomew A. Battista caused the funds’ failure to report a “material compliance matter”.  Rice failed to report violations of BlackRock’s private investment policy to the boards of directors.  BlackRock additionally failed to adopt and implement policies and procedures for outside activities of employees, and Battista caused this failure.  Battista agreed to pay a $60,000 penalty to settle the charges against him.

In SFX, the SEC charged the CCO for failed to supervise the president of the firm who stole $670,000, for violation of the custody rule, and for making a false statement in a Form ADV filing.  The CCO negligently failed to conduct reviews of cash flows in client accounts, which was required by the firm’s compliance policies, and did not perform an annual compliance review.  Mason also was responsible for a misstatement in SFX’s Form ADV that client accounts were reviewed several times each week.

Another was a technical interpretation case. In the Delaney case, the CCO was charged because the firm was failing to meet the requirements of 204T related to stock loans and execution of close-outs. The charges were for failing to give proper guidance on the rule, implementation of technology to comply with the Rule. The SEC position was that Delaney was that he knew the firm was violating the rule and did not take steps to stop it.

The SEC has said that CCOs are not targets. However, actions speak louder than words.

PRI finalizes ESG questionnaire

The Principles for Responsible Investment Initiative has launched the Limited Partners’ Responsible Investment Due Diligence Questionnaire to encourage standardized due diligence on environmental, social and governance considerations in private equity.

UN-PRI

The LP Responsible Investment DDQ was developed in consultation with a working group composed of 41 LPs, funds of funds and GPs.

There are 21 questions proposed to standardize the diligence framework in four categories:

  1. WHAT ARE YOUR ESG-RELATED POLICIES AND HOW DO ESG FACTORS INFLUENCE YOUR INVESTMENT BELIEFS?
  2. HOW DO YOU IDENTIFY AND MANAGE MATERIAL ESG-RELATED RISKS AND USE ESG FACTORS TO CREATE VALUE?
  3. HOW DO YOU CONTRIBUTE TO PORTFOLIO COMPANIES’ MANAGEMENT OF ESG-RELATED RISKS AND OPPORTUNITIES?
  4. HOW CAN LPS MONITOR AND, WHERE NECESSARY, ENSURE THAT THE FUND IS OPERATING CONSISTENTLY WITH AGREED-UPON ESG-RELATED POLICIES AND PRACTICES, INCLUDING DISCLOSURE OF ESG-RELATED INCIDENTS?

The LP Responsible Investment DDQ is accompanied by a guidance document.

Expect to start see these question on your investor DDQs.

Sources:

Happy Hanukkah

happy chanukah Hanukkah menorah

How Hanukkah Came to the White House by Jonathan D. Sarna in Forward.com

The first president who took official notice of Hanukkah was one of the Jewish community’s least-favorite occupants of the White House, Jimmy Carter. In 1979, he ended 100 days of self-imposed seclusion over the Iran hostage crisis by walking to Lafayette Park, lighting the new “National Menorah” erected there by Chabad-Lubavitch, and delivering brief remarks. Sensitized to the fact that Jews celebrate their own holiday in December, he carefully directed his next annual Christmas message only “to those of our fellow citizens who join us in the joyous celebration of Christmas.” Every president since has recognized Hanukkah with a special menorah-lighting ceremony, and limited his Christmas messages to those who actually observe the holiday.

Hanukkah came to the White House itself, in 1989, when President George H.W. Bush displayed a menorah there, given to him by the Synagogue Council of America. But the first president to actually light a menorah in the White House was Bill Clinton. In 1993, he invited a dozen schoolchildren to the Oval Office for a small ceremony. The event made headlines when 6-year-old Ilana Kattan’s ponytail dipped into the flame. Clinton ran his hands through her hair to snuff out the smoke. [more…]

 

Compliance Bricks and Mortar for December 4

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

Pigeon at Castelvecchio Verona

 

Your next PR battle is brewing in Private Funds Management

Last week, the California Public Employees’ Retirement System (CalPERS) released carried interest data that several media outlets were quick to spin as private equity somehow being more expensive than investors had realized, and that fees charged for outsized performance were egregious (when in fact they were shown to be below industry standards). It was yet another reminder that often the reporters writing such stories don’t understand the core concepts and structures of the asset class. [More…]

Making It Harder to Prove White-Collar Crimes by Peter J. Henning in the NY Times’ DealBook

But one provision tucked in the legislation could have a significant impact on prosecuting regulatory offenses, the type often pursued against businesses and corporate managers. The law would require that if a federal criminal offense did not specifically set forth the intent needed to establish a violation, then prosecutors must show the defendant’s state of mind was “knowing.” A further requirement is that “if the offense consists of conduct that a reasonable person in the same or similar circumstances would not know, or would not have reason to believe, was unlawful, the government must prove that the defendant knew, or had reason to believe, the conduct was unlawful.” [More…]

Is the City Link verdict a win for the industry? in Private Equity International

Former City Link directors must have breathed a sigh of relief. Last week a UK court found them not guilty of failing to notify the government of upcoming redundancies following the collapse of the company. [More...]

Investment Advisers Don’t Need Mystery Monitors by Norm Champ in the Wall Street Journal opinion section

Mandating examinations of investment-management firms by third parties presents all of the risks of these earlier failed attempts to outsource government power. These examinations would cost investment managers, and ultimately their clients, a great deal of money. The firms conducting the examinations would have a guaranteed revenue source with little incentive to produce quality exams or keep costs down. As with proxy advisory firms, the examining firms could develop their own agendas for examinations that have nothing to do with safeguarding investors. [More…]

Fairness of SEC Judges Is in Spotlight by Jean Eaglesham in the Wall Street Journal

The SEC won against 86% of defendants in contested cases in its own courts from October 2010 through September 2015, according to an updated analysis by The Wall Street Journal—significantly higher than the agency’s 70% win rate in federal court. A page-one Wall Street Journal article in May reporting the agency’s different win rates has since been cited in numerous legal challenges. [More…]

U.S. and UK risk assessments differ on real estate-related AML by Alex Zerden and Sarah Freuden in the FCPA Blog

The United States and United Kingdom recently published comprehensive money laundering risk assessments through the UK’s National Risk Assessment and the U.S.’s National Money Laundering Risk Assessment. The UK’s National RiskAssessment (NRA) and U.S.’s National Money Laundering Risk Assessment (NMLRA) provide insight into anti-money laundering vulnerabilities from real estate in two of the five largest global economies. [More…]

Pigeon at Castelvecchio, Verona is by Andy Hay
CC BY

The SEC Goes After the Gatekeepers: Grant Thornton Edition

“Audit firms must be held responsible when systemic failures such as inadequate engagement procedures, staffing, or supervision cause the firms’ work to fall significantly short of expected standards, particularly when multiple audits and engagements are involved.”

– Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.

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The SEC recently brought separate cases against senior housing provider Assisted Living Concepts and alternative energy company Broadwind Energy for disclosure violations.

When a fraud is uncovered, the Securities and Exchange Commission not only wants to get the fraudsters, it also wants to get those who should have stopped the fraud: the gatekeepers. The SEC also brought a companion case against those firm’s external auditors: Grant Thornton.

Assisted Living Concepts and Broadwind Energy both had the same engagement partner. The SEC brought charges against the engagement partner, Melissa Koeppel, and Jeffrey Robinson who worked on the Assisted Living Concepts audits.

Assisted Living Concepts had faked occupancy levels by including employees and other non-residents as occupants to meet loan covenants. The SEC order claims that the auditor was aware of this red flag and should have done more. If the firm had done so, it would have spotted the fraud.

“Grant Thornton was aware of red flags suggesting audit quality issues in the audits conducted by one of its engagement partners and its audit quality more generally, but failed to remedy the situation,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement

The SEC charges that the auditor should have spotted the issue with an impairment at Broadwind.

“They also failed to exercise due professional care and skepticism or obtain adequate audit evidence related to a significant bill-and-hold transaction.  The revenue from this transaction allowed Broadwind to meet its debt covenants.”

Without admitting or denying the SEC’s findings, Koeppel agreed to pay a $10,000 penalty and be suspended from practicing before the SEC as an accountant for at least five years, and Robinson agreed to pay a $2,500 penalty and be suspended from practicing before the SEC as an accountant for at least two years.

Sources:

Château de Crécy-la-Chapelle: Gate by Baishiya 白石崖
CC BY SA