Securities Compliance Sentinel - Analysis of Cutting Edge Securities Industry Issues

Recently, the SEC's newest commissioner, Commissioner Daniel Gallagher, discussed certain of his beliefs, including, among other things, that the SEC should use its exemptive authority derived from the Investment Advisers Act of 1940, to provide some relief for hedge fund and private equity investment mangers from the registration provisions of said Act. 

Gallagher believes that the full registration regime should not have been imposed upon investment managers for hedge fund and private fund advisers.  Essentially, he believes that the SEC should use its exemptive power to provide some "balm" to their predicament.  He also indicated that the SEC should rethink certain registration requirements if it does not promote capital formation.

Additionally, Commissioner Gallagher commented on the recent case of Theodore Urban, and his belief that the Commission should clarify when it believes that legal personnel are considered supervisors.  As many may know, the Commission deadlocked over the case, requiring the dismissal of the charges.  Commissioner Gallagher believes that it is important for the SEC to provide the standard for charging in-house counsel and other legal personnel in these matters.  Commissioner Gallagher hopes that the SEC will clarify this position through a Section 21A Report under the Securities Exchange Act of 1934.  He, however, said that there has not been a suitable case to do so as of yet. 

Commissioner Gallagher also has indicated that he believes that the SEC needs to provide a better framework to work with in-house legal and compliance officers of broker-dealers and investment advisers.  He believes that the SEC should utilize these individuals to accomplish its mission.  He also thinks that, if these individuals are engaged, as opposed to challenging them, or causing them liability, the SEC would be more likely to uncover fraud and protect investors.

Finally, as we move forward, it will be interesting to see if Commissioner Gallagher will influence the SEC to change.

Recently, the Department of Justice and the Federal Bureau of Investigation indicated that they are working on enough insider trading cases regarding the hedge fund industry to take them five years or more to complete.  This clearly indicates that the DOJ and FBI are going to continue to find insider trading actions with hedge funds.  This appears to be a “growth industry” for lawyers. 

Additionally, although the DOJ has recently been  the subject of much criticism because certain FCPA cases have collapsed, it has indicated that it will vigorously continue to prosecute FCPA actions.  The DOJ believes that this is part of a broader issue requiring enforcement.

Thus, there is no relief for the weary on the horizon.

The Co-Chief of the SEC’s Asset Management Enforcement Unit, recently, informed the public that the Staff will be paying particular attention to private equity firms.

The SEC Staff will be using the information it compiled from its risk assessment review of private equity firms in this endeavor.  These reviews will take note of valuations as well as other items including fees charged, broker dealer fees and tax and audit fees allocated to funds and investors.  No doubt much of the Asset Management Unit's focus will be a review of investment advisers/managers as well as fund structures.   

Nonetheless, the unit will, specifically, use the Aberrational Performance Initiative, the study that flagged hedge fund performance that appeared inconsistent with a fund's strategy or benchmarks.  The SEC Staff believes that this initiative will allow it to detect fraud earlier or prevent it, as the case may be.  The SEC Staff also warned that investment advisers with less than $25,000,000 in assets under management still must have strong compliance programs.  Essentially, the SEC Staff is suggesting no one is exempt.

In sum, we should expect to see more private equity funds on the SEC Staff's radar in the future.

Our partner, Miguel Pena, has put together a comprehensive guide on Delaware Trusts in an easily understood format.  The guide is attached for your use.  Contact Miguel with any questions.

Although the SEC’s rulemaking deferral regarding the uniform fiduciary standard has gained much press, the SEC's other rulemaking initiatives pursuant to the Dodd-Frank Act march on, and will have a significant effect on broker dealers and investment advisors in the upcoming year.

In particular, the SEC has scheduled a joint SEC-CFTC report to Congress on stable value contracts, and the adoption of rules pertaining to trade reporting, data elements and real time public reporting for security-based swaps.  Further, the SEC and CFTC will define key terms for swap products and intermediaries as well as security-based swap clearing agencies.  The SEC will also look to register and regulate security swap based data repositories and for mandatory clearing of security-based swaps.  Additionally, the SEC will look at the end user exceptions for the mandatory clearing of security-based swaps. 

The SEC will also consider a permanent rule to register municipal advisors this year.  However, certain controversial rules relating to conflict materials rule finalization and resource extraction disclosures as well as corporate governance rules relating to executive compensation claw backs, performance disclosure pay, compensation ratio and hedging policies have been pushed forward to the first part of this year.  Moreover, the SEC still has not set up certain offices that the Dodd-Frank Act required including, but not limited to, the credit ratings and municipal securities oversight function offices.  Currently, the SEC believes these functions are being performed by its Division of Trading and Market's Staff. 

In sum, the SEC’s Dodd-Frank Act rule making is still ongoing and will continue as it moves forward.

Over the last several weeks, the SEC staff made it abundantly clear that registered investment advisors must address social media communications in their compliance programs.

In particular, investment advisors should consider the frequency of monitoring content.  The SEC staff said that "after the fact" review may not be sufficient.  That is, the SEC may, ultimately, require that certain communications be reviewed before posting.  Accordingly, the SEC would require procedures in a registered investment advisor's compliance program to consider if the content should be approved before or after posting.

Registered investment advisors must also dedicate compliance resources that are sufficient to this endeavor, or consider employing outside monitors for these social media outlets.  Registered investment advisors must also adopt policies to address conducting firm business on personal or third parties sites, and if the social media sites pose any information security risks.

Additionally, these procedures must also address if client testimonials are posted on social media sights, including if it is acceptable, the client’s experience with or endorsement of an investment advisor.  Thus, the use of “plug-ins” or a “like” button may be testimonial in nature, and may not be permitted under the Investment Advisors Act.

We strongly urge investment advisors to consider these items in assessing their compliance programs and note that counsel may be able to assist in revising these programs to comply with these requirements.

The Securities Industry and Financial Market Association (“SIFMA”) indicated to its membership that those who engage expert networks – entities referring paid industry professionals to third parties for fees – should have in place policies, procedures, and training for their employees or others who engaged those services.  These expert networks have drawn regulatory attention, especially in insider trader investigations. 

These expert networks have found themselves in certain insider trading cases where it was alleged they tipped hedge funds or other investors in return for a cash payments.  Of course, this is more the breach than the rule, and the vast majority of expert networks would never do such a thing.  However, expert networks have become important in the financial system since they assist broker-dealers to design or implement investment strategies.  Nonetheless, broker-dealers should take precautions, as well as devise procedures to ensure that there is not even an appearance of impropriety. 

In sum, SIFMA believes that its membership should have policies to find and detect “red flags.”  These red flags will allow broker-dealers to ensure that their policies are being followed, especially, regarding material non-public information.  See Best Practices for Use of Expert Networks at http://www.sifma.org/uploaded files uploadedfiles/issues/legal_compliance_and_administration/expert_networks/expert-network-policy-bestpractices.pdf.

Thought you might be interested in a recent podcast I did concerning my securities law practice.  http://web.me.com/cordpar/Client_Development_Tips/Law_Consulting_Coaching_Podcast/Entries/2011/10/28_Developing_a_Securities%2C_White_Collar_and_Complex_Litigation_Practice.html

Over the last few days, a handful of eye-roll-inducing, easily-ignored activists calling themselves Occupy Wall Street grew into a large, multi-state movementthat demands our attention.  Thousands of protesters now gather in New York, Boston, Chicago, LA and other cities, protesting… well, something.  The inchoate mass lacks a singular focus –  activists carry signs ranging from “Pepper Spray Goldman $achs” ($ instead of S – clever!) to tried-and-true standbys like “Free Mumia” and “Meat is Murder.” 

Still, these protests are united by an undercurrent of anger at an economic system that has, in their eyes, rewarded the investment banks while the rest of us suffer through a recession that they caused.  It’s good old fashioned populism - the slightly late liberal counterpart to the Tea Party Movement. 

Both Occupy Wall Street and the Tea Party are reactions to the 2008 financial crisis and its long, ugly aftermath.  We shouldn't expect Occupy Wall Street to fade away anytime soon, as it has the potential to become a powerful, polarizing brand on the left, just like the Tea Party has been on the right.  With unions joining the protests in solidarity, this isn't just another excuse for kids who couldn't score Burning Man tickets to beat on some bongos: it's the start of a liberal movement which is seperate and distinct from Barack Obama.  As long as the economy remains in the doldrums, we can expect populist anger to remain frothy and available in every flavor. 

Noticeably and not-unexpectedly, few of the news reports I have read quote either Tea Party members or Wall Street Occupiers waxing philosophical on the latest rules and regulations emerging from the Dodd-Frank act.  While corporations, the SEC, the CFTC and others discuss how to implement what many call the most sweeping financial reforms since 1934, a large and diverse public does not seem satisfied.  Can we expect further legislation in the build up to the 2012 elections? 

In “This Time is Different” Carmen Reinhart and Ken Rogoff analyzed the financial crises of the last 800 years and found that they create a long period of sloth-like growth.  Normally, unemployment remains high for four to five years.  So far, they have been dead-on: good for them, bad for everyone else. 

And perhaps really bad for anyone hoping for less economic uncertainty.  Robust recovery appears to be over a year away.  A suddenly re-energized left, with elements of Ron Paul libertarianism thrown in, combined with a mobilized Tea Party could cause some havoc if they can inspire Congress to channel this incoherent anger.  More likely, however, is even more partisan gridlock, at least until November 2012.  Either way, the yawning disconnect between policy makers and the public continues to grow without signs of abating anytime soon, and that will make it even harder for businesses already mired in economic uncertainty. 

Reuters recently reported that the SEC and FINRA were asking trading firms specific details regarding their trading strategies and/or their secret computer codes. 

This new effort by the SEC and FINRA is part of a joint investigation into suspicious market activity as well as to examine compliance with securities regulations.  The specific requests relating to computer code, obviously, have irked many in the industry since the requests have to do with targeting stock trading firms and hedge funds.  These inquiries relate to trading information and computer coding information that may have been shared or “borrowed” with others, and used for illegal activity.  Clearly, the SEC and FINRA are focusing on this information to better understand the trading markets, but, of course, if they find anything of an illegal nature, it may result in enforcement examinations.

FINRA executives, recently, told a SIFMA conference that FINRA did not make these requests “lightly.”  However, this worries many since the information is privileged and proprietary, and may find its hands into competitors.  Although, the SEC and FINRA both have policies in place to protect such information, once the information is out, companies may find themselves in a predicament.  Counsel should certainly handle these particular issues.