Advanced Ethics

ReGroup designed effective ethics and education programs for investment advisers, private equity firms and hedge funds who are fiduciaries to their clients under the Investment Advisers Act of 1940. Advanced Ethics by ReGroup is designed to support ethical decision making by senior management through direct participation in a roundtable discussion of a complex case study, followed by a short presentation similar to the one presented here that summarizes the take-aways. www.regroupllc.com

Transcript

1. ADVANCED ETHICS ~A ROUNDTABLE CASE STUDY Ann Oglanian President, ReGroup, LLC aoglanian@regroupllc.com 415-681-2230 Kurt Wachholz Managing Director, Wellspring Compliance kwachholz@wellspringcompliance.com 404-236-9972
2. ©ReGroup, LLC, All Rights Reserved “I have an ethical dilemma. I just shortchanged an old lady $50… and I can’t decide whether I should split it with my partner.” 2 Is Business Ethics an Oxymoron?
3. ©ReGroup, LLC, All Rights Reserved  Lesson One: Perspective Matters  Lesson Two: Personal Relationships  Lesson Three: Telling the Truth to Power  Lesson Four: What Ethics Requires of You 3 Advance Ethics: Take-Aways
4. ©ReGroup, LLC, All Rights Reserved Principles vs. Methods "As to methods there may be a million and then some, but principles are few. The man who grasps principles can successfully select his own methods. The man who tries methods, ignoring principles, is sure to have trouble." ~Ralph Waldo Emerson 4
5. ©ReGroup, LLC, All Rights Reserved Lesson One: Ethics and Perspective  Jackie’s Story  Perspective matters • Did they see it as business ethics or protecting a friend? • Excerpt from “Why Do Good People Do Bad Things” at npr.org 5
6. ©ReGroup, LLC, All Rights Reserved The Fraud Triangle Opportunity Rationalization Motivation 6
7. ©ReGroup, LLC, All Rights Reserved The Fraud Triangle Opportunity Rationalization Motivation 7 Weak internal controls, complacency, collaboration Pressure, the market, incentive compensation, impossible targets A justification: “It’s good for the company” or “I’m being a good friend”
8. ©ReGroup, LLC, All Rights Reserved Lesson Two: The Ethics of Personal Relationships The $7M Fraud of Toby Groves  Mortgage company  People wanted to work at the firm because of Toby Groves was a great guy  Culture: if you do things right, you’ll be successful; no need to ever be dishonest  Financial problems - $250,000 in debt  Lied on his personal home loan application • Stated he was making $350,000/yr • “Just the cost of doing business” • Would be losing money forever… • Easy to lie…not much of a thought process  Loses mounted 8
9. ©ReGroup, LLC, All Rights Reserved The Second Bad Act  Entirely false loan called an “air loan” • Fraudulently documented a loan for a house that did not exist. Made up person, made up house, proceeds used to pay off debts  Requires help • Asked his staff to help fabricate documents  Openly admitted that he had messed up  Each agreed willingly; none stated any hesitation • Asked the bank to help fabricate the transaction  Openly admitted that he messed up  Two mortgage lenders agreed to help 9
10. ©ReGroup, LLC, All Rights Reserved Results  CEOs of two mortgage lending firms and Toby Groves served jail time  100 people put out of work  Multiple companies closed doors  Toby Groves started an ethics consulting practice 10
11. ©ReGroup, LLC, All Rights Reserved Fraud Requires Friends  Large fraud requires a lot of help  Why do we ask for help with wrongdoing?  Why do we agree to help?  Are you immune? 11
12. ©ReGroup, LLC, All Rights Reserved Aiding and Abetting and the Personal Relationship  “Aiding and abetting” is a separate crime from fraud • A plan to commit a fraud • Assistance in the furtherance of the plan  Encouragement is enough  Do not need to be present  Question: If a CCO is merely present when a the plan is carried out, but is silent, is he/she an accomplice?  Fiduciary duty is an affirmative duty, which means it include a duty to act, and would take into account the harm that could have been prevented if he/she had acted. 12
13. ©ReGroup, LLC, All Rights Reserved Breaking the Triangle  Breaking one element reduces the likelihood of fraud  Opportunity is reduced by internal controls  Rationalization is reduced by ______________? • No one will know • No one will get hurt • I deserve it  Motivation may be address through culture /structure • Threatening environment – if you don’t go along, you’re not on the team • Incentive compensation/impossible goals 13
14. ©ReGroup, LLC, All Rights Reserved Lesson Three: Telling the Truth to Power 14 The truth that makes men free is, for the most part, the truth which men prefer not to hear. ~Herbert Agar, A Time for Greatness
15. ©ReGroup, LLC, All Rights Reserved Shooting the Messenger  Sophocles' 4th century B.C. play Antigone • The King’s guards draw straws to choose the unlucky one who must tell his majesty the bad news  Ethical Challenge: • Speaking truth to power entails personal danger 15
16. ©ReGroup, LLC, All Rights Reserved Clarify the Ethical Dimensions of Your Firm (Your CEO)  Questions to ask before you need to: • Do you want me to tell you the truth? • Are there any circumstances under which you do not want to hear the truth? • Do you agree that when I tell the truth, I put myself at risk? • Will telling you the truth make me more valuable to you? 16
17. ©ReGroup, LLC, All Rights Reserved Caution: Whose Truth?  The ‘truth’ as you see it is perspective •Be prepared to support your version of the truth with facts •Understand and acknowledge where there are gaps in your truth •Never bend the truth for your own purposes •Never exaggerate 17
18. ©ReGroup, LLC, All Rights Reserved Actionable Principles  Conduct investigations activities objectively  Operate with transparency  Be accountable to all stakeholders 18
19. ©ReGroup, LLC, All Rights Reserved Escalation Thresholds  Evidence that a fraud or materials breach may exist should be brought to the attention of the proper level of management  Get an agreement in advance on what should be escalated to whom and when  Sample communication thresholds: The mere presence of a risk factor = no reporting Evidence that a fraud or breach may exist = reporting to the supervisor even if it is non-material Evidence that a fraud or breach did occur = reporting to the CEO/board. 19
20. ©ReGroup, LLC, All Rights Reserved A Ethics Waterfall Is it legal? Does it comply with our policies? Does it reflect our values and ethical principles? Does it respect our people, stakeholders, clients, partners, communities and planet? 20 Instructions: if the answer to any of the questions is ‘no’, then don’t do it. If you are still unsure, seek help.
21. ©ReGroup, LLC, All Rights Reserved Lesson 4: What Ethics Requires of You  Take action; timely  Be courageous  Tell the truth  Recognize perspective and bias  Be dispassionate  Be balanced  Be credible  Understand the limits of ethical process by recognizing human motivation  Learn to frame the business ethics issue as an business ethics issue  Do not assume that you’re immune 21
22. ©ReGroup, LLC, All Rights Reserved Overcoming the Fear of Ethics1  Fear: • Of the personal nature of ethics • That ethics is bad for business • That moral convictions are bad for your career  Only people at the top can act on their values  Employers do not want employees to act on ethical convictions  Cure • Engage in the dreaded activity with open discussion • Frame the question as a questions of ethics, not just of good business 22 1. "Do MBA Students Have Ethics Phobia?" Business and Society Review 53 Spring (1985): 52-54. Joanne B. Ciulla, Ph. D.
23. ©ReGroup, LLC, All Rights Reserved Legal and Regulatory Bases for Ethical Conduct by Legal and Compliance Professionals  1933 Securities Act  1934 Securities Exchange Act  1940 Investment Advisers Act  1940 Investment Company Act  ERISA  Section 307 of Sarbanes-Oxley Act of 2002 (SEC rules implementing professional responsibility for attorneys) 23
24. ©ReGroup, LLC, All Rights Reserved Advisory Professionals: Regulatory Framework  SEC: Section 206(1) and (2) of Investment Advisers Act of 1940 • Prohibited Transactions by Registered Investment Advisers  Rule 204A-1 of the Investment Advisers Act of 1940 • Investment Adviser Codes of Ethics 24
25. ©ReGroup, LLC, All Rights Reserved Advisory Professionals: Regulatory Framework  Rule 206(4)-7 of the Investment Advisers Act of 1940 • Compliance Procedures and Practices  Rule 17j-1 of the Investment Company Act of 1940 • Personal Investment Activities of Investment Company Personnel 25
26. ©ReGroup, LLC, All Rights Reserved Model Rules of Professional Conduct for the Legal Profession  American Bar Association Model Rules of Professional Conduct • Current as of today • Virginia Bar adopted the ABA Model  Preamble acknowledges that lawyers must be guided by “personal conscience” 26
27. ©ReGroup, LLC, All Rights Reserved Model Rules of Professional Conduct for the Legal Profession  Require honesty and integrity; one may not engage in conduct involving “dishonesty, fraud, deceit or misrepresentation” or make a false statement of fact.  See Rule 8.4  These concepts can be applied to compliance professionals as well. 27
28. ©ReGroup, LLC, All Rights Reserved Model Rules of Professional Conduct for the Legal Profession  A framework for the ethical practice of law • Not exhaustive of moral and ethical considerations  ABA Model is not designed to be a basis for civil liability. • Each state body that regulates lawyer conduct within its jurisdiction is free to adopt all or part of the Rules, or to reject them. 28
29. ©ReGroup, LLC, All Rights Reserved Model Rules of Professional Conduct for the Legal Profession  ABA Model and VA rules address eight separate areas: • Client-lawyer relationship • (Lawyer as a) Counselor • (Lawyer as an) Advocate • Transactions with persons other than lawyers • Law firms and associations • Public service • Information about legal service • Maintaining the integrity of the profession 29
30. ©ReGroup, LLC, All Rights Reserved CA Bar Current Rules of Professional Conduct for the Legal Profession* (current as of January 1, 2012)  California Bar rules address five separate areas: • Professional Integrity in General • Relationship Among Members • Professional Relationship With Clients • Financial Relationship With Clients • Advocacy and Representation *The Rules of Professional Conduct of the California Bar are currently being revised. 30
31. ©ReGroup, LLC, All Rights Reserved Overview: Attorney Conduct  Address various issues included in the Rules of Professional Conduct  The Rules of Professional Conduct and the various securities laws/regulations and Self Regulatory Organization (SRO) rules of practice  Discussion of recent regulatory and enforcement actions against such employees and several case studies  Attorney reporting rules • Sarbanes-Oxley requirements 31
32. ©ReGroup, LLC, All Rights Reserved Examples of State Bar Rules Relating to Legal and Compliance  The legal and regulatory bases for ethical conduct by legal and compliance personnel  CA Rule 1-100 Rules of Professional Conduct, in General  VA adopted ABA Model Preamble: A Lawyer’s Responsibilities  Advisers Act Section 206 Prohibited Transactions by Registered Investment Advisers  SEC v. Capital Gains Research Bureau, 375 U.S. 180, 194 (1963)  Fiduciary Duty 32
33. ©ReGroup, LLC, All Rights Reserved Examples of State Bar Rules Relating to Legal and Compliance  Maintaining clients' confidential information  Insider trading  Confidentiality policies and provisions in codes of ethics  CA Rule 3-100 Confidential Information of a Client  ABA Model and VA Rule 1.6 Confidentiality of Information  Advisers Act Section 204A Prevention of Misuse of Nonpublic Information  Advisers Act Rule 204A-1 Investment adviser codes of ethics 33
34. ©ReGroup, LLC, All Rights Reserved Examples of State Bar Rules Relating to Legal and Compliance  Financial relationships with clients with respect to gifts Business reality of client development  CA Rule 4-400 Gifts from Client  VA Rule 1.8 Conflict of Interest: Prohibited Transactions  ABA Model Rule 1.8 Conflict Of Interest: Current Clients: Specific Rules  Advisers Act Rule 204A-1 Investment adviser codes of ethics  NASD Rule 3060 Gifts and Gratuities  Notice to Member 06-69 Influencing or Rewarding the Employees of Others  Additional Guidance 34
35. ©ReGroup, LLC, All Rights Reserved Instructive SEC Enforcement Actions • In the Matter of Strong Capital Management, Inc. et al. (May 20, 2004)  http://www.sec.gov/litigation/admin/34-49741.htm • In the Matter of CapitalWorks Investment Partners, LLC and Mark J. Correnti (Jun. 6, 2006)  http://www.sec.gov/litigation/admin/2006/ia-2520.pdf • In the Matter of Consulting Services Group, LLC, and Joe D. Meals (Oct. 4, 2007)  http://www.sec.gov/litigation/admin/2007/34-56612.pdf • SEC Charges Hedge Fund Managers and Traders in $30 Million Expert Network Insider Trading Scheme (Feb. 8, 2011)  http://www.sec.gov/news/press/2011/2011-40.htm 35
36. ©ReGroup, LLC, All Rights Reserved Instructive SEC Enforcement Actions • In the Matter of Western Pacific Capital Management, LLC and Kevin James O’Rourke (Nov. 10, 2011)  http://www.sec.gov/litigation/admin/2011/33-9275.pdf • In the Matter of Donald Anthony Walker Young, a/k/a D.A. Walker Young and Acorn Capital Management, LLC (Feb. 28, 2012)  http://www.sec.gov/litigation/admin/2012/ia-3379.pdf • In the Matter of AXA Rosenberg Group, AXA Rosenberg Investment Management LLC and Barr Rosenberg Research Center LLC (Feb. 3, 2011)  http://www.sec.gov/litigation/admin/2011/33-9181.pdf • In the Matter of Envision Capital Management, Ltd. and Michael M. Druckman (Feb. 16, 2011)  http://www.sec.gov/litigation/admin/2011/33-9187.pdf 36
37. ©ReGroup, LLC, All Rights Reserved ReGroup Recommended Reading (see also attached bibliography)  The Committee of Sponsoring Organizations of the Treadway Commission, www.coso.org  The Power of Professionalism, Bill Wiersma  Berkshire Hathaway, www.berkshirehathaway.com • Code of Business Conduct and Ethics • Memorandum Re: “Insider” Trading Policies and Procedures • Corporate Governance Guidelines, January 7, 2010 • Memorandum from the Audit Committee to the Board of Directors, April 26, 2011 Re: Trading in Lubrizol Corporation Shares by David L. Sokol • Warren Buffett and Charlie Munger Interview transcription, with Carol Loomis (Fortune Magazine), Andrew Ross Sorkin (New York Times), Becky Quick (CNBC) 37
38. THANK YOU Ann Oglanian President, ReGroup, LLC aoglanian@regroupllc.com 415-681-2230 Kurt Wachholz Managing Director, Wellspring Compliance kwachholz@wellspringcompliance.com 404-236-9972 Ethics Education Experts