Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The OCC has issued interim examination procedures for Volcker Rule compliance.  The purpose of the interim examination procedures is to help examiners determine whether banks have business activities or investments that are subject to the regulations and, if so, to guide examiners in assessing plans that banks have developed and are implementing to comply with the regulations.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The SEC recently charged a hedge fund advisory firm, which we refer to as the employer, for the first time using its new authority to bring anti-retaliation enforcement actions.  The head trader for the employer reported to the SEC that improper, undisclosed principal transactions were occurring.

When the hedge fund advisory firm learned the whistleblower had reported the conduct to the SEC, the SEC alleged (which the employer did not admit or deny):

  • The employer informed the whistleblower that he would be removed from the employer’s trading desk and temporarily relieved him of his day-to-day trading and supervisory responsibilities. The employer informed him that, because he executed trades that were reported to the Commission, the employer needed to investigate his actions.
  • The employer further directed the whistleblower to work offsite at a different office building and instructed him to prepare a report that would detail all of the facts that supported the potential violations he reported to the Commission.
  • The whistleblower’s employment counsel proposed that the whistleblower be permitted to prepare his report from home rather than come into the office, which the employer allowed him to do. The employer and the whistleblower’s counsel also discussed the idea of the whistleblower leaving the firm in exchange for a severance payment.
  • The employer provided the whistleblower with a new email address for the purpose of communicating internally and externally as necessary to complete his report. The whistleblower worked remotely from home preparing the requested report and submitted it. On that same day, the whistleblower notified the employer that he intended to return to work on after the weekend.
  • The whistleblower emphasized that he was prepared to return to work but that he intended to return to his position as the employer’s head trader. The employer at that point made clear that the whistleblower would not return to his position as head trader until the employer’s investigation was complete. In the interim, the employer informed the whistleblower that he would be asked to perform tasks that were “meaningful and, to some extent, parallel or overlap those of head trader” and that “[it] need not explain further.”
  •  Despite the employer’s refusal to allow the whistleblower to return as head trader, the whistleblower returned to work as requested. Upon his return, he was no longer located on the trading desk and was placed instead in an office on a different floor. The employer informed the whistleblower that his first assignment and top priority was to identify any potential wrongdoing by the firm so that it could further investigate his allegations.
  • As part of that assignment, the whistleblower was asked to review more than 1,900 pages of hard-copy trading data, sorted by security. The whistleblower suggested that, rather than reviewing 1,900 pages of trading data, specific reports could be generated in an electronic format that isolate the specific trades that were potentially violative. He requested that he be provided access to the employer’s trading system so that he could generate the reports. The employer, after consulting with counsel, denied his request.
  • The employer maintained that the whistleblower could not return to the trading desk because the employer needed the whistleblower’s top priority to be identifying specific conduct that  could substantiate his claims of wrongdoing. Nonetheless, in response to the whistleblower’s allegations that the firm’s trading-related compliance policies were deficient, the employer tasked the whistleblower with the additional task of consolidating multiple trading procedure manuals into one comprehensive document and proposing revisions to enhance the firm’s trading policies and procedures.

The SEC alleged that the employer had no legitimate reason for removing the whistleblower from his position as head trader, tasking him with investigating the very conduct he had reported to the SEC, changing his job function from head trader to a full-time compliance assistant, stripping him of his supervisory responsibilities, and otherwise marginalizing him.

According to the SEC, as a result of the conduct described above, the employer violated Section 21F(h) of the Exchange Act, which prohibits an employer from discharging, demoting, suspending, threatening, harassing, directly or indirectly, or in any other manner discriminating against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower in, among other things, providing information to the SEC.

Obviously it looks like the employer did some things it shouldn’t have.  But the case seems to leave open the question about whether an employer can ever enlist a whistleblower to investigate and document wrongful conduct.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The Securities and Exchange Commission has recently increased its efforts in examining private equity fund advisers and the fees and expenses such advisers charge to portfolio companies on top of customary management fees. The SEC’s Office of Compliance Inspections and Examinations (OCIE) has implemented the Presence Exam Initiative to familiarize the industry with the increased regulatory oversight to come.

Andrew Bowden, the director of the OCIE, recently provided several insights into the initiative’s findings, emphasizing the substantive issues the SEC finds problematic. Notably, Bowden stated that over half of the private equity fund advisers reviewed thus far have been found in violation of the law or exhibiting material weaknesses in controls with respect to how fees and expenses are handled. In particular, Bowden cites inadequate disclosures and inadequate policies and procedures regarding these fees and expenses as primary deficiencies.

Given the SEC’s continued focus on private equity fund adviser fees and expenses, it is important to consider the areas of observed weakness articulated by Bowden in order to help ensure proper compliance and avoid regulatory action.

Key Issues
Bowden identified certain dynamics and trends in the private equity industry that create the potential for compliance difficulties, including the fact that while the industry has grown rapidly in size and complexity, compliance functions have not developed as quickly.

To promote increased compliance and disclosure, Bowden identified the following areas—based on completed examinations of newly-registered private equity fund advisers—where the OCIE has found the most deficiencies.

Limited Partnership Agreements
One common violation relates to the fees and expenses provisions in a portfolio company’s limited partnership agreement, which are often broadly worded and do not specify whether certain fees and expenses are borne by the adviser or the company. Particularly, these agreements can make it difficult to determine which fees and expenses are charged to the fund in addition to the adviser’s management fee. Moving forward, the OCIE expects the adviser’s fee and expense structure to be explicitly and carefully stated in the fund’s limited partnership agreement.

Consulting Fees
According to the OCIE, one of the most common problems with adviser fees and expenses relates to consultant and operating partner compensation. Bowden stated that because consultants often appear to be regular employees of the adviser, investors might expect their salaries to be paid out of the adviser’s management fee. However, in practice, consultant salaries are typically paid directly by the fund in addition to the management fee. The OCIE has taken the position that such consulting fee arrangements should be adequately disclosed to investors.

Other Hidden Fees and Expense Shifting
In addition, the OCIE has found violations with respect to “hidden” fees and expenses that have not been fully disclosed to investors. One example is billing for back-office functions such as accounting and legal services, which limited partners may incorrectly assume are included in the adviser’s management fee. Another is charging undisclosed administrative fees and other transaction fees not contemplated by the limited partnership agreement. Monitoring fee arrangements, particularly those that self-renew annually, continue past a fund’s term or include a termination fee, were specifically mentioned as types of problematic hidden fees.

Another concern is fee shifting that occurs during the middle of a fund’s life, when expenses are shifted from the adviser to the fund without disclosure. For instance, individuals who were initially employees of the adviser during fundraising may have been fired and then hired back as outside consultants, thereby shifting their salaries from the adviser’s management fee to the fund as additional expenses.

Valuation and Marketing
Examiners have also focused on valuation methodologies, finding that oftentimes the method used for valuation differs from the one disclosed to investors in the limited partnership agreement. Bowden has stated that the OCIE is not seeking to dispute fund valuations based on minor discrepancies, but is looking for specific valuation tactics (such as frequent changes in valuation methods from period to period or valuations that report returns before fees and expenses) and whether these tactics have been properly disclosed to investors.

The OCIE has identified related problems with certain marketing strategies used by fund advisers. Inflated valuations during fundraising, performance marketing using projections instead of actual valuations and misstatements about the investment team have been cited as the most common deficiencies with respect to marketing.

Recommendations for the Future
The recurring themes from Bowden’s discussion of the initiative and plans for continued SEC presence in the equity fund industry are compliance and disclosure. It is important for private equity fund advisers to review their current compliance procedures, identify any material weaknesses and consult with counsel to develop effective compliance programs that according to Bowden “bring controls and disclosures in line with existing requirements and investor expectations.” Such proactive steps can help fund managers avoid potentially unpleasant and costly SEC investigations.

SEC Commissioner Kara M. Stein recently gave remarks on the status of required Dodd-Frank rulemakings.  The pay ratio, claw back, conflict minerals and resources extraction rules didn’t really seem all that important to her though. I kind of agree, since I don’t really understand how these rules prevent another financial crisis.  She was focused on systematic risk.

Part of it is a trip down memory lane.  Ms. Stein said “I certainly remember looking at a streamlined, three-page document authorizing the expenditure of several hundred billions of taxpayer dollars—with almost no strings attached.  One doesn’t soon forget that.”  Yes, and I liked Hank Paulson’s plans.

Ms. Stein goes on to note “Many of the most important systemic risk reforms of the Dodd-Frank Act just aren’t done.  We need to finish these rules now; we cannot afford to wait.”

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

In 2013 the United States District Court for the District of Columbia vacated the SEC resource extraction disclosure rules that were mandated by Section 1504 of the Dodd-Frank Act. Fifty-eight Democratic lawmakers have recently sent a letter to SEC Chair Mary Jo White asking that the resource extraction rules be finalized “on a faster, more definite timeline.” The letter notes “Resource revenue transparency allows shareholders to make better-informed assessments of risks and opportunity costs, threats to corporate reputation, and the long-term prospects of the companies in which they invest. It is no surprise, then, that investors with assets worth over $5.6 trillion recently called on the SEC to quickly reissue a strong rule to align with transparency rules in other markets.”

In what may be as rare as a case of man-bites-dog, big players in the oil industries are begging for regulation and are also asking that the resource extraction rules be promptly finalized (see letters from Chevron and Exxon). The oil industry players note that England is likely to implement similar transparency legislation, and is willing to consider rules proposed by the SEC. And the rest of the European Union is likely to follow England’s lead.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The Federal Reserve Board has issued a proposed rulemaking that would implement Section 622 of the Dodd-Frank Act, which prohibits a financial company from combining with another company if the ratio of the resulting financial company’s liabilities exceeds 10 percent of the aggregate consolidated liabilities of all financial companies.

Financial companies subject to the concentration limit would include insured depository institutions, bank holding companies, savings and loan holding companies, foreign banking organizations, companies that control insured depository institutions, and nonbank financial companies designated by the Financial Stability Oversight Council, or FSOC, for Fed supervision.

Consistent with Section 622, the proposal generally defines liabilities of a financial institution as the difference between its risk-weighted assets, as adjusted to reflect exposures deducted from regulatory capital, and its total regulatory capital. Firms not subject to consolidated risk-based capital rules would measure liabilities using generally accepted accounting standards. The proposal would also provide that the Federal Reserve Board would measure and disclose the aggregate liabilities of financial companies annually, and would calculate aggregate liabilities as a two-year average. The proposal reflects recommendations made by the FSOC.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

A report issued by the organization Enough Project indicates market changes spurred by the Dodd-Frank Act’s provisions on conflict minerals have helped to significantly reduce the involvement of armed groups in eastern Democratic Republic of Congo in the mines of three out of the four conflict minerals.

The Enough Project conducted five months of field research in eastern Congo, interviewing 220 people in 14 mines and towns, in addition to 32 interviews in the U.S. and Europe. The research revealed the following findings and others:

  • Armed groups and the Congolese army are no longer present at two-thirds (67 percent) of tin, tantalum, and tungsten mines surveyed
  • The Dodd-Frank law and electronics industry audits have created a two-tier market for tin, tantalum, and tungsten (3Ts) from Congo and the region. Minerals that do not go through conflict-free programs now sell for 30 to 60 percent less thus reducing profits for armed groups trying to sell them
  • Bisie, one of the world’s largest tin mines which generated hundreds of millions of dollars for a number of armed groups and criminal units of the army, is now largely demilitarized
  •  Urgent reforms are needed for conflict gold, as gold continues to finance armed groups and Congolese army commanders
  • Electronics companies are expanding minerals sourcing from Congo, which is improving conditions for miners and communities near the mines. Twenty-one electronics and other companies now source from 16 conflict-free mines in Congo

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

The CFPB has launched an inquiry into the opportunities and challenges associated with the use of mobile financial services. As part of the inquiry, the Bureau is exploring how mobile technologies are impacting unbanked and underserved consumers with limited access to traditional banking systems.

According to the CFPB areas of focus include:

  • Access for the underserved: The Bureau is seeking information on whether using mobile devices opens up options in financial services and money management for these consumers; and whether these options are cheaper than traditional financial services. The Bureau is also exploring whether the increased use of mobile technologies could affect the availability and location of bank branches; and if so, what impact that would have on consumers.
  • Customer service: The CFPB is also seeking information on any additional protections consumers may need when they lose their device or if they get cut off from the cell or Internet service on their device.
  • Privacy concerns and data breaches: The Bureau is seeking information on what kind of information companies are collecting on consumers, whether it is being disclosed to consumers, and how that information is being used for low-income consumers in particular. The CFPB is also examining whether data breaches are more common on mobile devices as compared to traditional computers.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

We previously described a PCAOB reproposal regarding audit procedures for related party transactions.  A suggested audit procedure consisted of “Inquiries of the compensation committee chair and any compensation consultant regarding the structure of executive officer compensation.”  This part of the proposed standard was recently adopted by the PCAOB without any changes.  Subject to SEC approval, the new standard will be effective for audits of financial statements for fiscal years beginning on or after December 15, 2014.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.

 

 

The SEC has issued a series of FAQs on its final rule implementing section 13 of the Bank Holding Company Act of 1956 (“BHC Act”), commonly referred to as the “Volcker Rule.”

One FAQ covers the topic of “What does it mean for a covered fund to share the same name or a variation of the same name with a banking entity?”  Among other things, the staff of the SEC notes in order to comply with § 255.11(a)(6) of the final rule and not be considered to share the same name or variation of the same name with a banking entity, the name of a covered fund must be sufficiently distinct from the name of the banking entity that the covered fund’s use of the name would not likely lead to customer confusion regarding the relationship between the banking entity and the covered fund. For instance, a covered fund would generally be considered to share the same name or a variation of the same name with a banking entity if the name of the fund features the same root word, initials or a logo, trademark, or other corporate symbol that is also used by, or that clearly references a connection with, the banking entity, including any affiliate of the banking entity.

ABOUT STINSON LEONARD STREET

Stinson Leonard Street LLP provides sophisticated transactional and litigation legal services to clients ranging from individuals and privately held enterprises to national and international public companies. As one of the 75 largest firms in the U.S., Stinson Leonard Street has more than 520 attorneys and offices in 14 cities, including Minneapolis, Mankato and St. Cloud, Minn.; Kansas City, St. Louis and Jefferson City, Mo.; Phoenix, Ariz.; Denver, Colo.; Washington, D.C.; Decatur, Ill.; Wichita and Overland Park, Kan.; Omaha, Neb.; and Bismarck, N.D.

The views expressed herein are the views of the blogger and not those of Stinson Leonard Street or any client.