Happy Tax Day


No one likes Tax Day, but I would like to celebrate it by taking the day off. Be back tomorrow!

About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses. He is the author of the forthcoming book History of Money Laundering: How Criminals Got Paid and Got Away.


Inversion Mergers Raise Compliance Concerns

In 2014, many firms merged with foreign firms to execute an inversion so that they will be subjects of a different tax jurisdiction. The idea was to answer to foreign taxation first, only paying the difference, if anything at all, to the US government, creating massive savings. Inversion is a cross-border merger where the smaller foreign firm takes over a larger domestic firm. It is truly an inversion of the classic merger, but for the recent inversions, this is legal mumble-jumble. While technically the foreign firm took over the larger firm, the larger domestic firm is assuming a subsidiary role in name only. For this reason, The Department of Treasury started cracking down on foreign inversions.

image from Bloomberg Business

Now that the mergers have happened, in order to maintain the inverted status, a true merger must take place. That requires merging the operations of the two firms. All of the usual headaches of merger implementations apply. One of those headaches is compliance.

Inversion generally took place outside of the financial services world because that was an industry already global in nature on a firm to firm basis. So, the regulatory compliance issues pertaining to inverted firms are unique to each merger.

What isn’t unique is the US operations having to comply with foreign regulators. Here is where the US firm will need to be guided by their foreign counterparts, who may not be all that eager to help since the executives at the smaller foreign firm might be out of a job by the end of the year if the merger implementation goes smoothly.

And then then there are labors laws. The EU has TUPE — Transfer of Undertakings Protection of Employment. (Most of the inversion took place between US and Europe.) This protects many employees when transferring to new employers. Americans have long left unions behind but Europe is much more labor friendly. Shedding the European workforce after the merger might get tricky. Even complying with simple issues like mandatory national holiday and vacation day rules might create an inequality on which the US counterparts may demand parity.

And then there is the tricky situation of US expatriates working for the newly formed non-US firm. Are they still expatriates or are they immigrants? How these employees get paid, now that they are no longer working abroad for their firms?

A successful merger is a one time expense and, hopefully, in the mad rush to find foreign dancing partners, Americans didn’t partner up with one with two left feet. Constantly replacing one shoes will get expensive.

About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.


Death-Spiral Compliance

Have you heard of a Death-Spiral Convertible? This isn’t some car gone-bad. It also isn’t a new roller-coaster ride. It is a type of debt. It is a convertible because it can be converted into equity. It is called a Death-Spiral because it is an option only taken by public companies who are strapped for cash with no better options. Taking this option is could be a quick way to the death of the corporation, so, it should be only taken with no other options available.

Jason Sason of Magna investments
Jason Sason of Magna investments

Death-Spiral Convertibles recently came up in the news because of a young investor named Joshua Sason, who owns Magna Investments, recently made headlines by becoming a multi-millionaire using this lending method.

Here’s how it works:

A publicly traded company with low equity valuation in dire need of operating cash with no where to find it goes to an investment fund. They strike up a deal. The fund gives the company money in exchange for an IOU. One of the conditions of that IOU is that if the company cannot pay back the loan, the company will give equity instead. The value of the payment with equity is lower than the market value. Not just lower but a lot lower. Often, it is 25% or 25% of the market value. So, if the company’s shares are trading at $1 per share and the company was supposed to make $1,000 payment but did not have the cash to do so, it could pay 5,000 shares instead. Those share, of course, are valued at $5,000. Normally, a fund wouldn’t want to own shares of a company that can’t even pay its loans, but in this case, the shares are discounted so much that it can immediately sell the shares at a profit. If the conditions are right, the company cannot ever pay the monthly payments and the fund keeps getting those shares. The fund then sells those shares at a price that will guarantee them being sold, often at 50% of their market value. So, even though the fund was holding onto $5,000 worth of equity, since the fund doesn’t believe in the company’s ability to pay back its debt, it tries to unload the shares as soon as possible. Even at $2,500, the fund would have been paid, essentially, $2,500. That payment, of course, is made by the market, not the company, but the neither of them care. The company needs to keep cash and the fund wants to be paid back. Continue doing this every month for 6 months, and the fund would have diluted the equity in the market, it would have been paid handsomely, well above what it would have received it if the company could service its debts, and the share price plummets toward $0. This is a loan designed to kill the equity value. A fund that is interested in doing this would have to find a company that doesn’t have a chance of surviving.

This brings up an interesting compliance issue. Section 3 of the Securities Act of 1933 that deals with exceptions to normal equity underwriting requirements. Specifically, section 3(a)(10) deals with paying with equity for claims against the borrower. It allows these transactions with some conditions. So that not every equity offering doesn’t goes through this exception, the SEC allows the lender to sell the securities as a payment after holding onto it for at least three months. If the lender sells the equity into the public market in short order, the lender will be considered an underwriter, who may not be licensed to be an underwriter, let alone considered to be issuing unregistered stock.

For practical purposes, if you are a lender who wants to take advantage of this, selling the shares on the first day of the fourth month is a bad idea. Lenders who are interested in doing this have taken to doing it around six months. So, lenders are taking a risk for six months and hope that the company survives at least that long. SEC sees this as holding the securities long enough to be taking on a credit risk.

About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.

PayPal’s $7.7 million fine is a boost to CompliTech

PayPal Logo
PayPal Logo

Last week, PayPal, the eBay owned online payment company, was fined $7.7 Million for 486 OFAC violations. And that was a reduced fine just for 2013. 2014 investigations have not been completed at this time. That comes to nearly $16,000 per violation. Considering the number of transactions PayPal does, 486 is nothing. But then again, if fines were applied to a larger number of transactions, PayPal wouldn’t have a viable business model. And these violations were made with a strong compliance and anti-money laundering department. Imagine the violations without such a department in place.

PayPal and other Financial Technology (FinTech) firms are categorized as Money Service Businesses (MSB’s), not banks, because they do not offer depository services. this categorization does not absolve them from regulations pertaining to transactions and sanctions, like banks. Last week, they found out what it will cost them to stay compliant.

Generally, FinTech firms consider themselves to be the new alternative to banks. So, they don’t work with banks unless forced. So, compliance is not something FinTech spends a lot of time worrying about, resulting in less compliance experience.

Banks, however, despite their effort to reduce the effects of regulations, have been beefing up their compliance departments as well as vendor services. Some of the vendors are in the new sector of Compliance Technology, or CompliTech.

CompliTech has been around a decade or more but its recognition as a sector of its own is brand new. CompliTech is made up of a handful of firms across the US and Europe as well as groups within existing large bank systems providers. Their products are not yet fully tested, still require incredible amounts of human intervention and are expensive. Small financial players like community banks, credit unions and FinTech cannot afford their services.

But these are the very firms that need CompliTech services the most. If an organization is trying to provide inexpensive products and services with convenience without compliance programs afforded by economies of scale afforded at large institutions, they run a greater risk of serving cash-based businesses and immigrant populations with ties to foreign businesses. These providers face all of the threats of global banking without the benefits. To make matters worse, when a few CompliTech firms emerge as the leaders in the industry, big banks, bank systems providers and large consulting firms are more likely to snatch them up, leaving fewer options for FinTech to fend for themselves.

PayPal is an exception to all of this, as it is an exception in FinTech. It has been a round a while, it is large, and, these afford it a sophisticated compliance program. It hires PhD’s to do statistical analyses and ex-military intelligence officers to execute counter-terror financing. What startup can afford such programs?

CompliTech will eventually get around to serving FinTech. But until then, FinTech is far from taking over the transaction space.

About the Author: Marcus Maltempo is a compliance professional with more than a decade of experience helping banks, law firms and clients manage investigations and regulatory responses.