The ACA Hedge Fund Update is a blog series designed to complement our ongoing alerts and formal communications. This series provides insight into areas where ACA may not have traditionally been your primary trail guide. We hope you'll find this content informative and insightful.
Broken Windows 2.0
With U.S. Securities and Exchange Commission (SEC) Chairman, Jay Clayton, recently announcing his customary exit, media sources have suggested former U.S. Attorney for the Southern District of New York, Preet Bharara, as a candidate for SEC Chair. Bharara is commonly associated with his 85 straight insider-trading case convictions and a $1.8 billion settlement resolving insider trading charges with a hedge fund manager - the largest insider trading penalty in history. Bharara’s former boss and mentor, Mary Jo White, was the SEC chair from 2013-2017. Under her leadership, the SEC strived to be the cop on the beat that pursued all wrongdoing because, according to White, “…even the smallest infractions have victims, and that the smallest infractions are very often just the first step toward bigger ones down the road.” White likened the SEC’s mission to former New York Mayor Rudolph Giuliani’s “Broken Windows” approach to crime in the nineties whose pursuit of squeegee men and graffiti artists sent the message that no infraction was too small to be uncovered and punished. The chart below compares SEC enforcement case statistics between the SEC under Mary Jo White in FY 2016 and Jay Clayton during FY 20201 with the percentage increase under the White era referenced as the Broken Windows premium.
|Enforcement Category||FY 2016 (White)||FY 2020 (Clayton)||Broken Windows Premium|
|Stand Alone Enforcement Actions||548||405|
|Investment Adviser/Investment Companies||98||87||12.6%|
Although the SEC chair has not been named, we anticipate enforcement metrics to align closer with Mary Jo White’s SEC numbers in FY 2022 and for the remainder of the Biden/Harris administration.
OCIE Director Calls for CCO Empowerment
In his November 19, 2020 remarks at the National Investment Adviser/Investment Company Compliance Outreach 2020, OCIE Director Peter Driscoll reminded attendees of the compliance rule adopting release that stated an adviser's Chief Compliance Officer (CCO) should be competent and knowledgeable regarding the Advisers Act and should be empowered with full responsibility and authority to develop, implement, and enforce appropriate policies and procedures for the firm. The release also stated that a CCO should have a position of sufficient seniority and authority within the organization to compel others to adhere to the compliance policies and procedures.
Driscoll stressed the importance of CCO empowerment, seniority, and authority. He explained that one of the most significant aspects of an effective compliance program is having management support compliance and empower CCOs to perform their jobs effectively. However, he also specifically stated that OCIE staff notices:
- when firms hire someone for the role to check the box but do not support or empower them.
- when a CCO holds one or more roles in a firm and is inattentive to their compliance responsibilities.
- when a firm positions a CCO too low in the organization to make meaningful change and have a substantive impact, such as a mid-level officer or placed under the CFO function.
- when CCOs are expected to create policies and procedures but are not given the resources to hire personnel or engage vendors to provide systems to implement those policies and procedures.
- when a CCO is replaced because they challenge questionable activities or behavior.
- when a CCO is trotted out for an examination or sits silently in the corner in compliance discussions, overshadowed by senior officers.
- when a firm puts responsibility on the CCO for a failure of an employee or an officer to follow a firm policy or procedure.
Driscoll also cautioned that not only should CCOs be empowered and have authority, but CCOs, “…should not and cannot do it alone and should not and cannot be responsible for all compliance failures.”
CCOs operating in sub optimal empowerment or authority environments may consider summarizing these remarks and some of the compliance program risks identified in OCIE’s recent Compliance Program risk alert, which ACA summarized here, to their senior leadership teams. The remarks serve as a reminder that the CCO’s role and stature within the organization will be evaluated by OCIE and firms that have appropriate empowerment and authority environments could reduce regulatory interest.
IM’s New Web Intake Form for No-Action and Interpretive Relief
On November 17, 2020 the SEC’s Investment Management staff announced that the Commission website was updated to include a new web intake form for no-action and interpretive letter requests. The SEC staff requests firms use this form for all subsequent requests for no-action and interpretive letters. The Commission’s website also specifies the requisite information and procedures to follow. Whether this is purely a workflow efficiency tool or IM anticipates a marked increase in no-action or interpretive relief requests is not certain.
Whistleblower Receives $1.1 Million for “Independent Analysis” Leading to Enforcement Action
The SEC has awarded more than $720 million to 113 individuals since issuing its first award in 2012. Whistleblower awards can range from 10-30% of the money collected when the monetary sanctions exceed $1 million.
On November 13, 2020, the SEC announced an award of over $1.1 million to a whistleblower whose, “independent analysis led the staff to look at new conduct during an ongoing investigation.” The announcement explained that this whistleblower examined publicly available materials and conducted an analysis that revealed important new insights into the securities law violations, which helped the SEC protect investor assets from dissipation by the wrongdoer.
This case clarifies the SEC’s whistleblower office accepts more than tips of potential wrongdoing and is open to thoughtful individual analysis and research that identifies investor harm. This case also suggests that hedge fund investment professionals that do considerable forensic analysis of publicly available information may have additional economic incentives to share their research that identifies potentially fraudulent behavior.
TRACE Bribery Matrix Suggests Bribery Risk is Heightened in North Korea and Venezuela
Nordic countries (Denmark, Norway, Finland, and Sweden) along with New Zealand present the lowest corporate bribery risk in the world, while North Korea, Turkmenistan, South Sudan, and Venezuela present the highest, according to the 2020 TRACE Bribery Risk Matrix which measures business bribery risk in 194 jurisdictions. The U.S. ranked 23rd while the UK ranked 9th in terms of lowest risk. Compliance and due diligence professionals may consider incorporating the TRACE rankings to assist with risk assessment and resource allocation decisions.
Executive Order Prohibits Transactions in Issuers Associated with the Chinese Military
On November 12, 2020 President Trump issued an Executive Order on Addressing the Threat from Securities Investments that Finance Communist Chinese Military Companies. The order states President Trump finds that, “the People’s Republic of China (PRC) is increasingly exploiting United States capital to resource and to enable the development and modernization of its military, intelligence, and other security apparatuses, which continues to allow the PRC to directly threaten the United States homeland and United States forces overseas, including by developing and deploying weapons of mass destruction, advanced conventional weapons, and malicious cyber-enabled actions against the United States and its people” and that the President declares a national emergency with respect to this threat.
Effective January 11, 2021, the order prohibits any transaction in publicly traded securities, or any securities that are derivative of, or are designed to provide investment exposure to such securities, of any Communist Chinese military company as defined in the order. The order also states that additional issuers could be prohibited 60 days after a person is determined to be a Communist Chinese military company. U.S. persons are permitted to divest from affected securities acquired to the effective date of January 11, 2021 until November 11, 2021, or for a period of 10 months after the effective date of the prohibitions for any prohibited issuers designated at a later date (i.e., 365 days from the date any such entity is added to the prohibited list).
The executive orders defines the term “U.S. person” as any United States citizen, permanent resident alien, entity organized under the laws of the United States or any jurisdiction within the United States (including foreign branches), or any person in the United States. Since the purpose of the order is to restrict transactions in prohibited investments, the order appears to include U.S. financial intermediaries, such as broker-dealers and investment advisers, transactions on behalf of non-U.S. clients barring further clarification. Hedge fund managers may consider reviewing their portfolios for divestment candidates, accessing controls to prevent presenting orders in prohibited issuers after the effective date, and following the order closely as the Biden/Harris administration takes office.
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