These are some compliance-related stories that recently caught my attention:

The Fallout from the Latest NLRB Salvo on Social Media by Daniel Schwartz In Connecticut Employment Law Blog

[E]very pronouncement from the NLRB is treated as if it is written in stone with lots of suggestions on how to rewrite all of your policies.

The latest was an updated report last month from the NLRB on the topic again.  Rather than jump on board with a quick summary, I’ve decided to take a step back and really look at how significant this report really is.

According to Jon Hyman at the Ohio Employer’s Law Blog, it’s a ”mess.  In a mere 35 pages, the NLRB appears to have ripped the guts out of the ability of employers to regulate any kind of online communications between employees.”

Stressed-Out Compliance Officers May Soon Feel Even More Heat From SEC by Bruce Carton in Compliance Week’s Enforcement Action

Unfortunately, this stress level is about to go even higher for compliance officers at investment firms if the SEC follows through on a recent decision that such compliance officers may themselves be sued as “supervisors.” According to Investment News, the SEC “sees compliance as an area ripe for scrutiny.” At a compliance seminar in January, the SEC Enforcement Division’s Bruce Karpati, co-chief of the Asset Management Unit, said that “compliance programs are front and center for us. There’s going to be more soon on that in terms of enforcement actions.”

Crowdfunding and Other Recent Legislative Initiatives Focused on Capital Raising and Job Creation by Louis A. Bevilacqua, Joseph R. Tiano, Jr., David S. Baxter, Ali Panjwani and K. Brian Joe In Pillsbury’s Investment Fund Law Blog

This article summarizes various legislation introduced in Congress that would make it easier for smaller companies to raise capital and would lessen the regulatory burden on those companies.

2011 Annual FISMA Executive Summary Report (.pdf) from the SEC’s Office of Inspector General

The purpose of this law is to recognize the importance of information security to the economic and national security interests of the United States. The law emphasizes the need for organizations to develop, document, and implement organization-wide programs that provide security for the information systems that support the organization’s operations and assets, as well as information systems that are provided or managed by other agencies, contractors, or other sources.

The Foreign Account Tax Compliance Act of 2009 was part of the Hiring Incentives to Restore Employment Act of 2010 (the HIRE Act) passed in 2010. 

If you have foreign investors or domestic investors making their investments through offshore entities, you need to pay attention to this law. It requires private funds to collect information on their foreign investors to determine if there are any US investors in the ownership that may not be paying their taxes.

An investor’s failure to meet the regulatory disclosure requirements means that the fund manager will need to withhold 30% from distributions. These withholding obligations will go into effect on January 1, 2013.

The key benchmark is to identify a substantial US owner of an entity. Substantial starts at 10%.

I’m still trying to sort through the regulations to figure out how it will work. I think I can get it to tie into an anti-money laundering program. You should check an investors background. As part of that, you want to peek under the hood of an entity to see the ownership. I have seen people set a de minimis level between 5% and 50%. FATCA would seem to set the level at no less than 10%.

I expect many fund managerS are going to need to reach out to their investors and get more information and certifications from their investors to meet the FATCA standards.

Source:

Regulations Relating to Information Reporting by Foreign Financial Institutions and Withholding on Certain Payments to Foreign Financial Institutions and Other Foreign Entities (.pdf)

Private Equity has been siting on the fringes of Anti-money laundering regulation for many years. It’s still illegal to be involved in money laundering and fund managers should be taking some steps to protect themselves and to identify problems. There’s just no set script. FinCEN is supposedly working on a new rule.

In the meantime, FinCEn has issued a new rule setting out the requirements for Non-Bank Mortgage Lenders and Originators.

The rule starts with a simple principle based approach:

Each loan or finance company shall develop and implement a written anti-
money laundering program that is reasonably designed to prevent the loan or finance company from being used to facilitate money laundering or the  financing of terrorist activities.

What do you have to do to meet this standard? The rule goes on to set minimum requirements:

(1) Incorporate policies, procedures, and internal controls based upon the company’s assessment of the money laundering and terrorist financing risks associated with its products and services.
(2) Designate a compliance officer who will be responsible for ensuring that:
(i) The anti-money laundering program is implemented effectively
(ii) The anti-money laundering program is updated as necessary; and
(iii) Appropriate persons are educated and trained

(3) Provide for on-going training of appropriate persons concerning their responsibilities under the program.
(4) Provide for independent testing to monitor and maintain an adequate program, including testing to determine compliance of the company’s agents and brokers with their obligations under the program

 The mortgage company is also now explicitly required to file suspicious activity reports.

Obviously, private equity firms are not subject to this rule. However, I would guess that the proposed rule for private equity will end up having many of these same elements.

Sources:

• Financial Crimes Enforcement Network: Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Residential Mortgage Lenders and Originators (.pdf)
• FinCEN Requires AML Program and SAR Filing for Non-Bank Mortgage Lenders and Originators Reporting Would Assist Law Enforcement with Fraud Detection

There is a growing movement to create a new crowdfunding regime for raising capital. The models seem to draw inspiration from Kickstarter, a platform to fund creative projects. I say that because each time I see a draft bill it talks about an internet-based intermediary as part of the exemption.

President Obama endorsed the idea of a crowdfunding exemption. That has lead to three bills in Congress, plus a proposal being generated by NASAA as a state-run alternative.

President Obama cheered for crowdfunding as part of the American Jobs Act unveiling. The statement talks about the millions raised through Kickstarter in the form of donations. That’s not exactly right. The offering is sometimes a pure donation, but more often is linked to a product in development.

The Entrepreneur Access to Capital Act (H.R. 2930) permits “crowdfunding” to finance new businesses by allowing companies to accept and pool donations up to $5 million without registering with the SEC. It would limit individual investments to the lesser of $10,000 or 10% of an investor’s annual income. An amendment requiring a notice filing with the SEC was rejected as was an amendment that would have barred felons from being involved.

NASSA is putting together a model exemption for use at the state level. The various state level regulators are trying to craft this model.

The Democratizing Access to Captial Act (S.1791) was introduced by Senator Scott Brown. This bill is being supported by the Wefunders, who is in the business of being a platform for capital crowdfunding. Unlike Kickstarter, it’s only open to accredited investors.

Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2011 (S. 1970) was  introduced by Senator Merkley. This bill has the right acronym.

What they all have in common is some cap on the total funds that can be raised and a cap on how much someone can invest.

I’m all for making it easier for entrepreneurs to have easier access to capital. The registration and legal limits on capital-raising deter lots of projects. However, they also vet projects. To some extent, excluding the unworthy. It also tends to deter lots of worthy projects.

I like the project crowdfunding at Kickstarter. There is no expectation of riches, other than whatever trinket or completed example of the project they promise to you in exchange for your funding. I have no concerns about the dilution of shares, executive compensation, ratchets, and follow-up rounds.

Capital crowdfunding should be an interesting experiment. I predict it will create lots of new jobs and fund lots of interesting projects.

I also expect that it will be suspect to fraud. I expect that there will be many disappointed small investors who expected to reap fortunes, instead being stuck with worthless shares in failed companies or companies that existed only to funnel cash to fraudsters.  The extent of that fraud will depend on how well Congress crafts a crowdfunding bill. I expect they will come up short.

Sources:

• NASAA’s Model Crowdfunding Exemption – the Internal Draft from William Carleton

It’s sad day in Boston. We’ve become accustomed to winning and the Super Bowl drought continues for at least another year. There were two compliance-related stories that came out of Super Bowl XLVI.

The first was singer M.I.A.’s obscene gesture and expletive during the halftime show. After Janet Jackson’s nipple-gate incident eight years ago, you would think the network would keep a finger close to the censor button during halftime. Perhaps they were too closely following Madonna and forgot about the other performers.

Madonna hasn’t been controversial for two decades. Others on the half-time show stage have been known to do and say things that would violate network standards.

The second compliance-related incident was the reluctant touchdown by Ahmad Bradshaw as time was winding down in the fourth quarter. Was his job to score touchdown? or to help his team win? usually, those goals are aligned.

By scoring that touchdown, he gave his team the lead, but also gave Tom Brady more time to mount a comeback. (A comeback that failed. ) If Bradshaw had managed to sit down on the 1 yard line, the Giants would be able to burn more time off the clock and just have to make a relatively easy field goal.

The Patriots had a similar problem. Rarely is a defense called up to let the opposing team score.

Even firms where conflicts of interest are well managed need to realize that sometimes the alignment of interests breaks down. Sometimes, doing the right thing for the organization is different from what you are used to doing.

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

Private Equity Bets On Compliance Market With EthicsPoint Deal by Nick Elliott in WSJ.com’s Corruption Currents

In a further sign of rising demand for compliance services, private equity firm Riverside Co. has signed a deal to acquire EthicsPoint Inc., which it will merge with its existing portfolio companies ELT Inc. and Global Compliance Services Inc.

Treasury Will Work to Satisfy EU Privacy Concerns Regarding Provision of FATCA Information and Gradually Phase In FATCA Regulations in Jim Hamilton’s World of Securities Regulation

The Foreign Account Tax Compliance Act can be implemented in a way that is not overly burdensome when compared to its benefits and, over time, will serve as a complement and a catalyst to the ongoing global efforts to combat offshore tax evasion, said a senior Treasury official. In remarks at the annual meeting of the New York State Bar Association tax section, Acting Assistant Secretary for Tax Policy Emily McMahon said that Treasury is aware that FATCA imposes significant new duties on foreign financial institutions, but also noted that FATCA was enacted in the wake of serious offshore tax evasion.

The Gun Sting Case Defeats and What it means For FCPA Enforcement? Absolutely Nothing! by Tom Fox

In a stunning rebuke of the Department of Justice’s (DOJ) trial strategy, all defendants in the second group of Gun Sting defendants walked out of the federal courthouse, still free. Two defendants were acquitted and the remaining three defendants were granted a mistrial. One defendant was dismissed at the close of the prosecution’s case in December as was the DOJ’s Foreign Corrupt Practices Act (FCPA) conspiracy count against all defendants. So, as the FCPA Professor noted, the DOJ is 0-10 in trial prosecutions in its Gun Sting case. However, that stark number does not tell the full picture of what is going on in enforcement of the FCPA.

What everyone missed in Facebook’s IPO filing in Alison Frankel’s On The Case

The New York Times reported in Dec. 2010 that the SEC was looking into the red-hot secondary market for trading in the privately-held shares of Facebook, Zynga, LinkedIn, Twitter, and some other Internet darlings. The leading market-maker for such trading, SecondMarket, confirmed last January that it had received a voluntary request for information from the SEC (which has never confirmed the investigation). But Facebook is the first company to offer any hard facts about what the agency is probing.

My Favorite Risk Factors in the Facebook S-1 by Seattle lawyer William Carleton

1. The Threat of the Open Web
2. User Disdain for Advertising
3. Conflicts with Independent Developers
4. A Fine Point About Fiduciary Duties

With the announcement of the Oscar nominees, try watching Margin Call to combine movie watching and compliance. Margin Call received an Oscar nomination for best original screenplay.

The movie sets Kevin Spacey, Demi Moore, Jeremy Irons, Stanley Tucci, and Simon Baker as the key players at an investment firm during the earliest hours of the 2008 financial crisis.

Tucci is the head of risk management for the mortgage trading desk, but gets laid-off in the first few minutes of the film. On his way out, he hands an unfinished project to a low-level risk analyst to find the problem. He finds it and it’s big. The holdings on the mortgage desk could lead to the downfall of the firm. that leaves it up to the firm’s employees on whether to save the firm at the risk of fleecing millions of investors.

Unlike Inside Job, Margin Call does not paint the characters as evil, mustache-twirling, robber barons. They’re humans staring at the face of a monumental choice. One choice is to hold and likely bankrupt the company. The other is to sell the garbage and likely being painted as a bad guy. They’re up all night thinking about the problem and trying to find a way out. Dawn comes and they all need to make choices.

Early versions of Dodd-Frank had an exemption from registration for private equity fund managers, just as there is one for venture capital fund managers. Perhaps there is some hope that the private equity exemption will once again surface?

Don’t count on it.

Although I appreciate the efforts of Congressmen Hurt, Cooper, Garrett, Himes, and others. They wrote a January 30 letter to the Securities and Exchange Commission urging the SEC to “delay the March 30, 2012 registration deadline and to exempt advisers to private equity funds that are not highly leveraged at the fund level from the new registration requirements.” They point out that The Small Business Capital Access and Job Preservation Act has a new registration exemption for private equity. Unfortunately, it’s been sitting dead since it was passed by the House Financial Services Committee in June 2011.

The congressmen’s argument:

In addition, [the Congressmen] believe that requiring registration by private equity fund advisers not only misdirects resources at private equity firms but also at the Commission. As a result of private equity fund adviser registration, the Commission will have hundreds of new firms to oversee and inspect. The Commission’s resources will thus be diverted away its core responsibilities of protecting retail investors and other new oversight priorities that can contribute in a meaningful way to financial stability.

It’s a nice argument, but too late. The registration deadline is March 30, but the filing deadline is February 14. Private equity firms already have their resources allocated or are very far along in gathering them up.

I’ve heard some whispers from limited partners indicating they are concerned that private equity is fighting against SEC registration under the Investment Advisers Act. Although it’s a good regulatory scheme for hedge funds, there are many items in the scheme that is a poor fit for private equity. The insider trading requirements and custody rule are at the top of my list.

Sources:

• Letter to the SEC (.pdf)
• House Members Ask SEC to Delay Registration of Private Equity Fund Advisers in Jim Hamilton’s World of Securities Regulation

James H. Freis, Jr., Director of the Financial Crimes Enforcement Network, let us know that his agency is working on anti-money laundering requirements for investment advisers. At a November 15, 2011 speech at the American Bankers Association/American Bar Association’s Money Laundering Enforcement Conference he highlighted many of the issues of money-laundering in the various financial sectors. FinCEN‘s rules currently apply to broker-dealers and to mutual funds, but not to investment advisers.

On May 5, 2003, FinCEN published a notice of proposed rulemaking in the Federal Register proposing that investment advisers establish anti-money laundering programs. But it never went anywhere. On November 4, 2008, FinCEN announced that it was withdrawing the proposed regulations and would not proceed with regulations for these entities without publishing new proposals and allowing for industry comments.

“FinCEN is currently revisiting the topic of investment advisers, building on the changes to that industry pursuant to the Dodd-Frank Act, the SEC rules implementing Dodd-Frank and other changes, and is working on a regulatory proposal that would require investment advisers to establish AML programs and report suspicious activity.”

The investment adviser line of business has lots of business models. Shortly, the ranks of investment advisers will be flooded with private fund managers. Fries cites these statistics:

“According to the Investment Advisers Association, the number of investment advisers registered with the SEC totaled 11,539 in 2011, and the total assets under management reported by all investment advisers increased 13.7% to $43.8 trillion in 2011, from $38.6 trillion in 2010.28 According to the SEC, there are more than 275,000 state-registered investment adviser representatives and more than 15,000 state-registered investment advisers.29 Approximately 5% of SEC-registered investment advisers are also registered as broker-dealers, and 22% have a related person that is a broker-dealer. Additionally, approximately 88% of investment adviser representatives are also registered representatives of broker-dealers.”

Clearly, it’s a big industry. Clearly, working with “bad guys” on any of the blocked persons lists would be a big problem.

However, the private equity fund vehicle is an unlikely choice for someone to launder money. The investment is highly illiquid, the subscription commitment requires you to contribute money infrequently over a long period of time, and the money is distributed back irregularly.

I welcome some clarity from FinCEN, but hope they are realistic about the burdens they will impose in contrast to the risk.

Being a lawyer, I like a good legal thriller. If you’re looking for a legal thriller to keep you up at night, try William Landay’s latest novel: Defending Jacob. Jacob is a fourteen year old boy whose classmate is found murdered. Jacob’s father is an assistant district attorney. You can guess from the title that Jacob gets accused of the crime.

Before I go on, I should point out a few of my biases. I’m friends with the author. Our sons went to daycare and preschool together for many years. So I see bits and pieces of him and his family in the story. (But not that I think Bill’s son will grow up to be accused of murder.) I think I see flashes of Bill, his family, and the community in the book. Maybe that distracted me from the characters or maybe it made me like them more. I’m not sure.

Not being a trial lawyer, I can’t vouch for authenticity of investigative procedures or the trial. Again, with a title like “Defending Jacob” you would expect there to be a trial. You end up with the expected clash between the clash of guilty and not guilty against the question of whether Jacob actually committed the crime.

That’s what kept me reading chapter after chapter. Who was Jacob? Could he have committed the crime? Did Jacob’s father really know who he was? Facts quickly start being revealed, twisting the story through reveals and lies. It pushes the father, son, and mother to the edge until…

Defending Jacob should be on the bookshelf of your local bookstore on January 31 and is also available through Amazon.