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
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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
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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
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New York’s Proposed Anti-Money Laundering Regulations Could Send CCOs to Jail

To start with the obvious, helping terrorists and drug kingpins with their finances is bad. The US regulatory machine has been clamping down tighter on financial institutions who engage in this bad behavior. As the bad acts continue, the regulators keep tightening the regulatory requirements. The latest tightening of the screws comes from New York.

laundering dollar bills money

Governor Andrew M. Cuomo announced that New York is proposing a new anti-terrorism and anti-money laundering regulation that includes a requirement modeled on Sarbanes-Oxley that the chief compliance officer certify that their institutions has sufficient systems in place to detect, weed out, and prevent illicit transactions. That potentially opens the certifying officer to criminal charges if the certification is incorrect or false.

It’s hard to argue against anti-money laundering regulatory requirements. The regulator’s stock response is “Then you are in favor of financing terrorists.” Nobody is in favor of that. A few greedy financial executives have gone bad and that causes the rest to endure increasing scrutiny.

The key question is who is going to get caught up in these proposed regulations.

§504.3 Transaction Monitoring and Filtering Program Requirements.
(a) Each Regulated Institution shall maintain a Transaction Monitoring Program…

§ 504.2 Definitions.
(e)“Regulated Institutions” means all Bank Regulated Institutions and all Nonbank Regulated Institutions.

(b) “Bank Regulated Institutions” means all banks, trust companies, private bankers, savings banks, and savings and loan associations chartered pursuant to the New York Banking Law (the “Banking Law”) and all branches and agencies of foreign banking corporations licensed pursuant to the Banking Law to conduct banking operations in New York.

(d) “Nonbank Regulated Institutions” shall mean all check cashers and money transmitters licensed pursuant to the Banking Law.

That moves the regulatory requirements into an area I’m no longer familiar with. New York banking law licensing and charters is outside my scope of knowledge.

The regulations go on to require the Chief Compliance Officer or functional equivalent to file an annual certification.

[T]he undersigned hereby certifies that they have reviewed, or caused to be reviewed, the Transaction Monitoring Program and the Watch List Filtering Program (the “Programs”) of (name of Regulated Institution) as of ___________ (date of the Certification) for the year ended________(year for which certification is provided) and hereby certifies that the Transaction Monitoring and Filtering Program complies with all the requirements of Section 504.3.

This is most likely not applicable to most fund managers not associated with licensed banks. We still need to keep an eye on FinCEN who is working on a new anti-money laundering requirement for registered investment advisers.

Sources:

Laundering Dollar Bills is by TaxRebate.org.UK
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Dealing With Leftovers

If your Thanksgiving was anything like mine, you have leftover food. It’s a poor allocation of resources, but Thanksgiving has turned into a weekend of excess. Excess food, excess shopping, excess football, excess dessert, excess waistline. Perhaps your compliance program is also filled with leftovers.

leftover turkey

Very few compliance officers would say that they have more resources than they could possibly need or put to good use. Compliance departments are not packed full of tupperware with stuff to be used later. Compliance is a cost center.

Most firms are not starving their compliance programs, trying to trim fat. A typical fund manager wants to bountiful compliance program that addresses the risks to the firms. Regulators and, more importantly, investors expect and demand a robust compliance program.

Are there items on your compliance program that are related to risks no longer present at the firm. Do you have that container full of leftovers from 2009 hiding in the back of your fridge taking up room?

Leftover Turkey by Andrew Nash
CC BY SA

 

When a Compliance Officer Breaks Bad

There has been considerable discussion in the compliance community around the Securities and Exchange Commission bringing charges against compliance officers. There are three areas that the SEC feels it is justified in bringing charges: (1) when the compliance officer is involved in the wrongdoing; (2) when the compliance officer impedes the examination or investigation; and (3) when the compliance officer is in wholesale failure. The latest SEC charges against a compliance officer fall into the first area.

Breaking Bad long

Yue Han was an associate in the compliance department of Goldman Sachs. That gave him access to the emails of the investment bankers to look for potential misconduct. The SEC claims that Mr. Han broke bad and used the information he gathered from those emails to spot upcoming M&A activity for his own personal gain.

Mr. Han has not settled the charges so this story is based only the SEC’s allegations. He left the country and may not dispute the charges. The SEC has gotten an asset freeze, so he will have to fight the claim if he wants the cash back.

The SEC claims that its case stems from its Market Abuse Unit’s Analysis and Detection Center, which uses data analysis tools to detect suspicious patterns. The SEC claims that its enhanced detection capabilities enabled SEC enforcement staff to spot Han’s unusual trading activity in two different accounts.

Four companies are at the center of the SEC’s case: Yodle, Zulily, Rentrak, and KLA.  In each case, he bought out-of-the-money options cheaply just before an acquisition was announced and recognized a big gain after an acquisition was announced. Goldman Sachs was an adviser in each of the deals.

In one of the Han trading accounts, the broker-dealer barred him from acquiring further trading in the account. I assume the firm noticed the suspicious trading.

The complaint leaves out whether or not Mr. Han cleared his trades with Goldman. I would assume not since the firms would have been on the blocked list.

I would guess that Mr. Han is not going to dispute the charges and try to re-gain his trading profits.

Sources:

 

Happy Thanksgiving

That means an extra long weekend for me. In Boston, the big traffic rush was on Tuesday night to avoid the traffic on Wednesday. I think most people have a half day on Wednesday or the day off. I hope you get to enjoy a long weekend before the push for year-end.

I’m going for the #OptOutside Friday instead of Black Friday. Look for me on bike, heading somewhere.

turkey thanksgiving

It would not be a holiday without some kind of government action. On Thanksgiving we get the presidential pardon of a turkey (or two): The Definitive History of the Presidential Turkey Pardon.