Month: September 2016

California’s Private Fund Disclosure Bill

California’s soon to be enacted new law, AB 2833, requires every California public investment fund to require its alternative investment vehicle fund managers to make disclosures regarding fees and expenses.

welcome-to-california

AB 2833 mandates that that every California public investment fund (that includes CalSTRS and CalPERS) must make the following disclosures at least annually:

  • The fees and expenses the fund pays directly to the alternative investment vehicle, the fund manager or related parties.
  • The fund’s pro rata share of fees and expenses that are paid from the alternative investment vehicle to the fund manager or related parties. In lieu of having the alternative investment vehicle provide this information, the fund may calculate it using information contractually required to be provided by the alternative investment vehicle.
  • The fund’s pro rata share of carried interest distributed to the fund manager or related parties.
  • The fund’s pro rata share of aggregate fees and expenses paid by all of the portfolio companies held within the alternative investment vehicle to the fund manager or related parties.
  • Any additional information already required to be disclosed under the Public Records Act in regards to alternative investments.

The law defines “alternative investment” as “an investment in a private equity fund, venture fund, hedge fund, or absolute return fund.” That leaves me wondering if the term is intended to include real estate funds.

 The bill applies to new contracts that the public investment fund enters into on or after January 1, 2017, and to all existing contracts pursuant to which the public investment fund makes a new capital commitment on or after January 1, 2017.

Sources:

State Line 2-welcome-to-california
CC BY
Phillip Capper from Wellington, New Zealand

Compliance Bricks and Mortar for September 9

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

bricks curvy

Whistle-Blowing Insiders: ‘Game Changer’ for the S.E.C. by Peter Henning in DealB%k

Since the program’s creation in 2011, the S.E.C. has received more than 14,000 tips, including almost 4,000 last year. That number falls well short of the original estimate of 30,000 submissions each year, but quality is far more important than quantity. Not surprisingly, agency officials heap praise on the program. Mary Jo White, the S.E.C. chairwoman, called it “a game changer for the agency,” while the director of the enforcement division, Andrew J. Ceresney, said that whistle-blowers “had a transformative impact.” [More…]

Tribute to Star Trek and Anti-Corruption Programs by Tom Fox in FCPA Compliance & Ethics

The Original Series, now termed Star Trek – The Original Series (TOS), largely worked because of the interplay of the show’s three main characters, Captain Kirk, Mr. Spock and Dr. McCoy as representations of the Greek terms ethos, pathos and logos.

…

All of this dovetails into compliance as well. The three basic tenets of a best practices compliance program are to prevent, detect and remedy. [More…]

Is this the first shot in the SEC’s war against social media? by Joshua Horn in Securities Compliance Sentinel

The SEC can also use this information on an ongoing basis to assess what firms are putting out there on social media. The industry has to assume that the SEC will be doing more with this information than just tucking it away for examination purposes.Core Values

This new rule should incentivize you to review your social media policy, assuming that you have one. If you do not have one, you need to have one prepared. [More…]

Is This The SEC Or The Lotto? by Keith Paul Bishop in California Corporate & Securities Law

The SEC’s total payout is impressive, but the number of payees is extremely small. According to the SEC, awards were paid to only 33 persons. Moreover, 77.6% of the payout, or $83 million, went to just 4 whistleblowers. From inception through fiscal 2015, the SEC received a total of 14,116 whistleblower tips and made payments to 22 persons. Based on these numbers, the probability of receiving an award is 0.00155. In comparison, the California Lottery posts the odds of winning $10 on its $1 “Set For Life” Scratchers game at 0.00962, or more than 6 times better. [More…]

Joe Murphy to courts and regulators: Stop undermining compliance by Joe Murphy in the FCPA Blog

But there is a nasty little secret behind this conclusion. The legal system, which is supposed to help prevent business crime, actually undermines company compliance efforts. Instead of providing substantial incentives and recognizing the value of our work, there are strong undercurrents that undermine our efforts. [More…]

 

Is The SEC “Kicking and Mutilating The Corpse”?

I have a written a few stories on the SEC’s case against Louis Schooler and his firm, Western Financial Planning Corp. The Securities and Exchange Commission brought charges against them for a real estate investment scheme. Schooler was selling general partnership interests that owned real estate using what looked like inflated valuations.

hylas

By default general partnership interests are not securities, but the judge found that a general partnership could be an investment contract (and therefore a security) if one of three factors is present.

(1) the general partnership agreement leaves so little in the hands of the partners that the arrangement in fact distributes power as would a limited partnership;

(2) the partners are so inexperienced and unknowledgeable in the general partnership business affairs that they are incapable of intelligently exercising their partnership powers; or

(3) the partners are so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that they cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers.

Schooler has continued to fight the decision, but has been hit with having to pay $150 million in disgorgement.

The SEC took an additional approach and sought to bar Schooler from the securities industry. That raised my eyebrow because Schooler does not think he is in the securities industry. He is claiming to be selling real estate interests. I’m not sure how much the bar would work. It’s a bit of a circular argument.

It does not seem to matter because Schooler decided to take some time off and go sailing in the South Pacific on his Hylas 42 sailboat: Entertainer. I’m sure that the many people who lost money in Schooler’s investment scheme have some bad thoughts of that image of him sailing alone in the tropical breeze.

Those investors are likely believing in karma now. Schooler did not appear for the ruling. He has gone missing in the South Pacific.

That did not stop the SEC from finalizing the industry bar. It also lead to his lawyer’s charge that the SEC’s Enforcement Division “is acting out of pure vengeance and spite, akin to not only killing a person, but kicking and mutilating the corpse.”

The SEC’s response:

“[T]here has been a report that Schooler’s yacht ran aground on a reef in or around Tahiti, no remains were recovered, and no death certificate has been issued. At present the U.S. State Department considers Schooler to be missing rather than dead.

I’m sure that there are many, like me, wondering if this is straight out of a movie. Did Schooler set up an elaborate scenario to fake his own death? Latitude 38 says some circumstances of the shipwreck are suspicious.

Neither scenario does anything to help those who lost money by investing with Schooler.

Sources:

 

 

Weapons of Math Destruction

With big data, comes formulas to parse through the data trying to make sense of it. Those algorithms can help make sense of the data and help filter through the noise to find trends. But those algorithms can also be easily misused and have harmful, if unintended consequences. Cathy O’Neil explores these problems in Weapons of Math Destruction.

weapons of math destruction

Ms. O’Neil is a former academic, hedge fund quant, and data scientist for startups. At the hedge fund she was looking at ways to make money by predicting financial trends. As a data scientist she was looking to predict people’s purchases and browsing habits to monetize those habits. Those are good algorithms where the people using them understand them and update the algorithms as they see problems and can check to see if they are working properly by verifying outcomes.

Many data driven outcomes fail. Those are the focus of Weapons of Math Destruction.

I’m a big fan of the Slate Money podcast with Cathy O’Neil, Felix Salmon, and Jordan Weissmann. When the publisher offered me a review copy of Ms. O’Neil’s book, I jumped at the chance.

It’s a short book and even though the title makes it sound like it’s full of math, it’s not. It’s more about social policy. She points to the danger of decision makers blindingly following algorithmic output that they do not understand.

Take the US News and World Report listing of best colleges. This is preeminent guide for high school students trying to figure out which college to attend. The rankings do not look at actual student outcomes. The publisher does not look at happiness, learning or improvements. It looks at proxies for the outcomes like SAT scores, alumni contributions, and graduation percentages. Colleges started making decisions to improve their rankings in the algorithm by improving those measured proxies. As anyone writing checks for their college bound children, affordability is not one of the measured proxies.

As you might expect there are big chunks of the book dedicated to failings in the financial sector by relying on poorly designed algorithms. The biggest problems often being false assumptions plugged into the data running through the algorithm.

With the election season upon us, the chapter on political algorithms is fascinating. The data scientists of commerce were brought into political campaigns. They are able to micro-target potential voters sending different messages to different groups highlighting the positions that would make the candidate more favorable to that segment of the population. Civic engagement and the political process is increasingly being algorithm driven.

Since our world is increasingly being driven by big data, it’s important to understand what is happening behind the decision-making. Weapons of Math Destruction is an excellent tool to help you understand data driven decision-making.

Compliance Bricks and Mortar for September 2

These are some of the compliance-related stories that recently caught my attention. Maybe you need something to read over Labor Day Weekend?

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Conflicted Feelings About Conflict Minerals by Matt Kelly in Radical Compliance

Don’t die of shock, but a new government report finds that compliance with the Conflict Minerals Rule is still sputtering.

That’s the overall conclusion of the latest Government Accountability Office review of conflict minerals compliance, which is pretty much the same conclusion as last year’s GAO report. Companies are marginally better at determining where their conflict minerals come from. They are not any better at determining whether their conflict minerals somehow fund African warlords.  [More…]

Companies Lack Active-Shooter Plans by Ben Dipietro in the WSJ’s Risk & Compliance Journal

A survey of about 900 organizations found while 69% of respondents listed an active-shooter situation as one of the biggest threats to workplace safety, 39% said their organization doesn’t have a communications plan in place to deal with such an incident. Even at those organizations that do have a plan, 79% said their organization isn’t fully prepared. The survey from critical communications services provider Everbridge Inc. highlights the risks companies face as they try to protect employees and others from potentially deadly office attacks, said Imad Mouline, Everbridge’s chief technology officer. [More…]

Why You May Want To Reconsider Promising Confidentiality To Whistleblowers by Keith Paul Bishop in California Corporate & Securities Law

The scope of the promise may be unclear.  Often, the promise of confidentiality is as succinct as “All reports and disclosures you make under this Code of Ethics will remain confidential unless required to be disclosed by applicable law.”  The company may believe that it is agreeing not to disclose the reporting person as the source of the disclosure.  The reporting person may take the position that the company has agreed not to disclose either the fact of the report or its substance, particularly when either may serve to identify the whistleblower. Misunderstandings about what was and was not promised may lead to litigation [More…]

Ethics for ethicists? A Code of Ethics and Compliance Professionals by Joe Murphy in the Compliance and Ethics Blog

As children we learn the story of the cobbler’s children. The person who makes the shoes for the village is the one whose children lack shoes. It is an ironic picture—those whose job is to provide a product in fact do without the product themselves. And yet, in the compliance and ethics field, where we spend our days telling corporate clients how to act legally and ethically, and we routinely push them to adopt and apply codes of conduct, do we follow this advice ourselves? [More…]

The Hedge Fund Trader Who Beat the Feds by William D. Cohan in Fortune

Hedge fund manager Todd Newman’s successful career was upended when he was prosecuted for insider trading. After his conviction was thrown out on appeal, the case became a landmark in Wall Street regulation. An inside look at what it’s like to be stalked by the feds—and not back down.[More…]

Umbrella Registration

Continuing with my look at the changes to Form ADV, I spent some time looking at the new umbrella registration.

Umbrellas_at_Caudan_Waterfront_Mall

One investment adviser (“Filing Adviser”) will be able to file a single Form ADV on behalf of itself and other investment advisers (“Relying Advisers”). This tackles the problem fund managers had when the manager was a collection of separate fund advisers.

For a variety of tax, legal and regulatory reasons, private fund managers are often carved into separate legal entities even though they operate together. There may just be a collection of fund general partners, even it looks like a single adviser to the outside.

Form ADV is based on the legal entity and therefore skews the information since the separate legal entities would have to file separate Form ADVs (or is it Forms ADV?). The SEC had provided some guidance for umbrella registrations in 2012, but there were complications around ownership on Schedules A and B.

For a group of private fund advisers that operate as a single advisory business to qualify for Umbrella Registration, they must meet these five requirements:

  1. The Filing Adviser and each Relying Adviser advise only private funds and/or “qualified clients” in separately managed accounts that are otherwise eligible to invest in the private funds advised by the Filing Adviser or a Relying Adviser and whose accounts pursue investment objectives and strategies that are substantially similar or otherwise related to those private funds.
  2. The Filing Adviser’s principal office and place of business is in the United States, and all of the substantive provisions of the Advisers Act and rules apply to the Filing Adviser and each Relying Adviser.
  3. Each Relying Adviser, its employees, and persons acting on its behalf are subject to the Filing Adviser’s supervision and control.
  4. Each Relying Adviser’s advisory activities are subject to the Advisers Act and rules, and subject to SEC examination.
  5. The Filing Adviser and each Relying Adviser operate under a single code of ethics and written policies and procedures adopted and implemented in accordance with rule 206(4)-7 of the Advisers Act and administered by a single chief compliance officer in accordance with the rule.

There is a new Schedule R for information on the Relying Advisers.

Sources:

Umbrellas at Caudan Waterfront Mall by Martin Falbisoner CC BY SA