Spicing Up the 10-K

On August 5th, SEC will vote on a rule that would publish the ratio of CEO compensation to the typical worker of their own firm. This disclosure is required by Dodd-Frank, but, as with many laws, the details and implementation makes all of the difference in the world. SEC has delayed the implementation of this requirement, but I don’t really know why, other than CEO’s don’t like the idea.

I don’t like the idea because it unnecessarily target the CEO over other top executives. The likely comparison will be made between the CEO and an average of some pool of individuals, which is unfair. The better comparisons are with individuals against individuals or pools against pools.

full-trailer-for-50-shades-of-grI’m in favor of pools. The pools should be large and the distinction should be simple and indicative of something important. If the pay disparity is what the SEC wants to highlight because it feels that bigger disparities lead to more compliance issues, then they need to identify what is driving the disparities within the organization. Across the board, the biggest portion of disparity is equity compensation. The two pools should something quite simple. My suggestions: compare average total compensations where more than 50% of the total compensation is equity versus less.

Here’s the other problem with this disclosure: what is defined as the organization. I’m assuming Goldman Sachs does not hire any janitors. Janitors are employees of an outside firm. But Goldman Sachs wouldn’t exist without working in buildings of some sort. So, in terms of running the company called Goldman Sachs, some manager has to decide what janitorial company will be responsible cleaning their offices. As long as having offices is part of Goldman Sach business model, office cleaning services are part of its business. But legally, those janitors don’t work for Goldman Sachs. These types of outsourcing is usually on the low end of the payscale, unnaturally raising the average of the lower pool.

Similar pool problem are labor market disparities. A company whose employees are primarily in Bangladesh will be paying their lower pool significantly less than the upper pool. At the same time, the disclosure is actually made worse but hiding the disparity it is actually trying to reveal: American disparity. So, does one exclude foreign employees?

Still, the greatest benefit to my proposal is getting an understanding about how what the pay disparity is between those who are working to pump up the value of their stock and those who are trying to increase their cash compensation. This will also require the firm to put everyone in two buckets, forcing them to make a decision about what roles should be trying to pump up the stock and what roles are to be productive.

But these are implementation problems. Politicians and interested parties are still arguing over whether such information in important to shareholders. Republicans are saying that the purpose of the rule is to produce societal pressures on corporations, not actually add informational value to shareholders. I don’t have a problem with putting societal pressures on corporations, but I do wonder if this really should be the role of the SEC or if it should be the role of the DOL. Democrats and Labor are saying that  the information is going to be important for shareholders because they will be given another key piece of information about how to pay their executives, which shareholders do in a vote each year.

Should corporations be required to disclose the pay ratio between its top executive and the average worker in the firm?

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.

Alibaba is being kicked out of Taiwan

Jack Ma, Founder & CEO, Alibaba Group

Alibaba, the Chinese AmazoneBayPaypalDHL all-in-one, has been ordered to leave the Taiwanese market by Taiwanese regulators. It ran afoul of a law that required all mainland Chinese companies to go through a special registration in Taiwan to do business there. The Taiwanese subsidiary was registered as a fully controlled entity of Alibaba’s Singaporean subsidiary. The Singaporean subsidiary is a wholly controlled by the Mainland company, making the Taiwanese subsidiary a Singaporean company in name only.

Regulators discovered that Alibaba had not passed the registration process required of Mainland companies when reviewing Alibaba’s filings with the SEC in the United States. Alibaba filed papers with the SEC to publicly trade its equity shares in the US markets.

The purpose of the law is to prevent the Communist Party from taking a hold on the island.

Founder and CEO of Alibaba is the every so charismatic Jack Ma.

Taiwan’s official name is Republic of China, not to be confused with Mainland’s official name, People’s Republic of China. The Taiwanese government was formed when the Communist Party kicked out the party from the Mainland. In the early days after the communist revolution, most western powers recognized the Taiwanese government to be the legitimate government of China. Unofficially, US President Richard Nixon recognized the Communist Party as the ruling party. And officially, US President Jimmy Carter recognized the Communist Party as the ruling party. Since the turn of the century, Republic of China has been on a campaign to consider itself an independent nation, seeking a seat of its own in the United Nations and developing diplomatic relationships across the globe. Also, it has supported a grassroots campaign in the United States to have US citizens and permanent residents of Taiwanese decent to identify themselves as “Taiwanese,” rather than Chinese, in public and on the census.

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.


AML Means Anti-Money Laundering

Money Laundering is the process of making earning from criminal activities into legitimate money. It’s called “laundering” because the money from criminal activities is considered “dirty” money, so, “laundering” it would “clean” it. AML is the activity of preventing and identifying those activities.

The general process of money laundering begins by placing the dirty money into the financial system, layering it under the cover of a legitimate business and then integrating it by acquiring the funds legally. There are various strategies and tactics to successfully laundering money but with the aid of technology and broader reach of the global financial system, it is much more difficult to succeed.

Van Heusen Advert via Erotic Mad Science

Because there are so many ways and so many places criminals try to launder money, there are many organizations involved. FATF was formed to provide guidelines for enforcement of anti-money laundering activities. All of the financial regulators are involved in oversight, review, exam and enforce AML activities. Intelligence and law enforcement organizations are also involved because the criminal activities tend to be mixed with other criminal activities.

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.

DPA Means Deferred Prosecution Agreement

Deferred prosecution agreements (DPAs) encourage individuals and companies to provide the SEC with forthcoming information about misconduct and assist with a subsequent investigation. In return, the SEC refrains from prosecuting cooperators for their own violations if they comply with certain undertakings. – SEC

DPA’s are also used by the DOJ.

For a company or an individual who may have unwittingly been involved in financial crime, DPA is often the best option. There are two main types of DPA’s, with and without admission of violation.

Obviously, not admitting to violation is the best option. This option can only be provided if the violator’s intended results were not a violation in themselves. This doesn’t mean it’s the end of the violator’s troubles. The violator may face professional punishments if s/he is licensed or certified. In rare cases, the violator will be barred from the profession.

Wolf of Wall Street by Martin Scorsese via Aerometal

Admitting to the violation only strengthens the case against the violator’s disbarment. On top of that, the violator may face disbarment from the industry regardless of the function. Admission could be career suicide.

It used to be that corporations wanted to avoid admission because it meant suicide for the corporation. But last year, the regulators showed their willingness to work with corporations on leniency, if that’s what it can be called. A number of corporations entered into agreements to admit to wrong doing and pay hefty violations but DPA’s were executed in such a way so that corporations may have taken a hit to their assets, but the shareholders’ equity would not be affected.

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.

FCPA Means Foreign Corrupt Practices Act

Foreign Corrupt Practices Act (FCPA) is a legislation that prohibits publicly traded companies and their agents from bribing foreign officials and related-agents for business. Its goal is to stop bribery in all its forms so that companies compete in the market by lowering prices, producing better goods and providing better services. FCPA is a broadly defined.

The Department of Justice (DOJ) and Securities And Exchange Commission (SEC) are in charge of enforcement. the SEC has produced a resource guide along with a section of its website dedicated to topics related to this legislation. The legislation was enacted in 1977. The DOJ has also provided the Act in its entirety, but it is good to keep in mind that there is extensive case law that has provided interpretations to the Act’s language. The DOJ provides an extensive database of related opinions to help a professional navigate the changing nature of interpretation.


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.