The Morning Risk Report: “Culture of Compliance” Won"t Always Stop Fraud

Matt Keel, chief compliance officer at investment firm Sentinel Management Group Inc., said at the trial of the firm’s chief executive Eric A. Bloom that he still believed his former boss to be “an honest person…with high integrity.” Mr. Keel, according to prosecutors, had previously lauded Sentinel’s “strong culture of compliance” in a report.

Mr. Bloom was convicted on Tuesday of defrauding customers out of $500 million via a misuse of their funds that Mr. Keel didn’t know about at the time, according to his testimony. Terry Campbell, a lawyer for Mr. Bloom, said he would ask the judge to overturn the verdict and intends to appeal. Mr. Keel isn’t the first compliance officer at an investment firm to be embarrassed by the conduct of the boss: Russell Wasendorf Sr., who is currently serving jail time for fraud, fabricated documents that misled his chief compliance officer and many others besides.

How can compliance officers catch such deception? Sen. Debbie Stabenow, in a hearing on the Wasendorf fraud held in 2012, suggested attention to internal controls might have provided early warning of that fraud. What is “the trust but verify position…from a customer standpoint, what is the verification? What is the independent verification?,” she asked Dan Roth of the National Futures Association. Mr. Roth, president of the self-regulatory body, responded by outlining additional safeguards the NFA planned to make. Otherwise, at least compliance officers at investment advisory firms can expect some backup from the government, after a first-of-a-kind case last August in which the Securities and Exchange Commission punished an adviser for deliberately misleading his CCO.

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EXCLUSIVE ON RISK COMPLIANCE JOURNAL:

SEC drops some charges against Noble execs. The Securities and Exchange Commission dropped internal controls charges in a civil foreign bribery case against a current and a former executive at Noble Corp. Former Noble Chief Executive Mark A. Jackson and James J. Ruehlen, director of Noble’s subsidiary in Nigeria, both of whom are accused of violating the Foreign Corrupt Practices Act by the Securities and Exchange Commission, are scheduled to go on trial in July, having been moved from an earlier scheduled date in April.

Treasury puts sanctions on Afghan trafficker. The U.S. Treasury Department said Wednesday it placed Kingpin Act sanctions on Afghan national Pahlawan Rozi for his alleged role running a money-transfer business, known as a hawala, and trafficking drugs.

RISK

Ukraine roils GE’s Russia strategy. In a matter of weeks, General Electric Co.’s Russia business has gone from holding promise to a holding pattern, the WSJ reports. GE took in $1.7 billion of its total $146 billion in revenue from Russia in 2013–”a rounding error,” said one person familiar with the company’s thinking. But the company has been counting on Russia as a source of sales growth, and the crisis in Ukraine is a looming problem for the company’s interests. “There’s a gorilla outside the door,” this person said, “and I don’t know how we’re going to deal with it.”

Chinese importers scotch deals. Chinese importers of soybeans and rubber are backing out of deals, adding to a wide range of evidence showing rising financial stress in the world’s second-biggest economy, the WSJ reports. Most purchases are private, with little data on the volumes affected, but traders at Asian trading firms say they are seeing a sharp rise in canceled contracts this year while other buyers are demanding heavy discounts.

More merger suits filed, with less success. Corporate mergers are often fraught with uncertainty over whether the deal will succeed, culture clashes between the two companies and the fate of executives. But two things are virtual locks: The companies will get sued by shareholders unhappy with some aspect of the deal, and eventually they will settle with the offended parties without significant changes to the transaction, the WSJ reports. Shareholders challenged 94% of U.S. public-company deals last year, up from 44% in 2007, according to Cornerstone Research, a litigation consulting firm. But the recent proliferation of legal actions has diluted their power, people on both sides of these cases say. “It’s a classic case of crying wolf,” said Sean Griffith of Fordham University School of Law. “If the goal of the legal system is to add value for shareholders, it’s failing.”

COMPLIANCE

Dutch firm allegedly laundered money for Libyan leader. Palladyne International Asset Management BV was a “kickback and money laundering operation” for the former Libyan dictator Moammar Gadhafi’s regime, a former executive alleged in a lawsuit filed this week, the WSJ reports. Palladyne is a focus of investigations into whether Goldman Sachs Group Inc. broke anticorruption laws in its dealings with the Libyan sovereign-wealth fund, said people familiar with the matter. A spokesman for Palladyne called the allegations “entirely untrue and ludicrous.”

Casinos may have to vet customers. U.S. casinos may soon have to vet the source of their high rollers’ funds under a requirement being developed by the U.S. Treasury Department, Reuters reports. The move is part of a push to address longstanding regulatory and law enforcement concerns that criminals can use casinos, which have not historically been as closely monitored as banks for compliance with anti-money laundering laws, to convert proceeds of crime into money that appears clean.

SP wants to split fraud suit. Standard Poor’s Ratings Services wants to split up the federal government’s $5 billion fraud lawsuit into separate trials, according to the WSJ. SP argues that it is unreasonable for one jury to digest the “crushing amount of evidence” that would be presented in a single trial, according to a Tuesday filing in a California federal court. SP wants an initial trial to start in September 2015 and be limited to a subset of mortgage bonds that allegedly suffered losses and were owned by Citigroup Inc., according to the court filing. The remaining alleged losses and bonds would be dealt with in a trial at a later date, SP stated in the filing.

U.K. probing energy companies. The U.K.’s electricity and gas markets regulator on Thursday proposed an investigation into whether effective competition in the energy market is being stifled, the WSJ reports. The investigation would be carried out by the Competition and Markets Authority. The Office of Gas and Electricity Markets, or Ofgem, said that a state of the market assessment report confirms its previous analysis of why competition isn’t working well and reinforces concerns about barriers to entry for independent suppliers and persistent high market shares of the largest energy companies.

UBS suspends forex traders. UBS AG suspended foreign-exchange traders in the U.S., Singapore and Switzerland as its investigation into the alleged rigging of currency markets widened, according to Bloomberg.

DATA SECURITY

Target, Visa say fraud limited after breach. Target Corp. said it has seen relatively little fraudulent activity on its cards following a massive data breach over the holidays, comments that came as the retailer faced harsh criticism from lawmakers for data-protection shortcomings that may have facilitated one of the largest payment-card thefts in history, the WSJ reports. Target Chief Financial Officer John Mulligan at a Senate Commerce Committee hearing Wednesday that there been $2 million in fraud on the Visa credit cards it issues and none on Target’s store-issued debit cards. Ellen Richey, chief legal officer at Visa Inc., said the percentage of cards stolen during the Target breach that have been used for fraud is much lower than the 2% to 5% rate that the card issuer normally sees in such circumstances due to the relatively quick notification of the breach.

GOVERNANCE

CEO pay rising but not for all. CEOs are still making plenty of money. But a wave of investor activism is helping keep a lid on growth in pay, according to the WSJ. Compensation for corporate chiefs increased only slightly in 2013, and pay packages remained closely tied to a company’s performance or the fate of its stock, according to a survey of early proxy filings by the Hay Group for the WSJ. That was the third straight year of moderate growth. The survey looked at 50 public companies that brought in at least $8 billion in revenue. The median rise in pay was 4.1%—slightly faster growth than in 2012 but well below the median 25% shareholder return for the companies that were analyzed.

Activist investors leak plans to a favored few. Shares of Rino International Corp. sank 28% in the two days after investment firm Muddy Waters LLC put out a report attacking the Chinese company’s accounting. Three investment firms were ready for the news. The firms had been tipped beforehand by Muddy Waters about the scathing November 2010 report, according to a person close to the matter, who said one of them made a bet against Rino stock that produced a $1 million-plus profit. “We sold advance copies of our report,” said Muddy Waters’s founder, Carson Block, adding that since then he has tried to limit advance knowledge of his firm’s research. For a new breed of “activist” investors, tipping other investors is part of the playbook. Activists, who push for broad changes at companies or try to move prices with their arguments, sometimes provide word of their campaigns to a favored few fellow investors days or weeks before they announce a big trade, which typically jolts the stock higher or lower, reports the WSJ.

REPUTATION

Yum Brands puts out new menu in China. U.S. restaurant chain Yum Brands Inc. launched a new menu and marketing campaign in China on Thursday, aiming to regain customer confidence after reported overuse of antibiotics by some of its chicken suppliers created a backlash, the WSJ reports. The Louisville, Ky., company is rolling out new menu items, including two new chicken sandwiches, three rice dishes as well as drinks and desserts for its China-based KFC outlets, according to a statement from the company.

 

 

The Morning Risk Report: “Culture of Compliance” Won"t Always Stop Fraud