Scherzer Blog

SEC’s proposed rule requires issuers and underwriters of asset-backed securities to make due diligence findings available to the public

The Securities and Exchange Commission (SEC) issued on October 13, 2010 a proposal to enhance disclosure to investors in the asset-backed securities market. The proposed rule requires issuers of asset-backed securities (ABS) to perform a review of the assets underlying the securities, and publicly disclose information relating to the review. The proposal also requires an issuer or underwriter of ABS to make publicly available the findings and conclusions of any third-party due diligence report.

The SEC’s proposed rule would enhance ABS disclosure in three ways:
Issuers of ABS that are registered with the SEC would be required to perform a review of the bundled assets that underlie the ABS.
Proposed amendments to Regulation AB would require an ABS issuer to disclose the nature, findings and conclusions of this review of assets.
Issuer or underwriter of both registered and unregistered ABS offerings would be required to disclose the findings and conclusions of any review performed by a third-party that was hired to conduct such a review.

In addition to this rule, the Commission last week proposed regulations that require issuers of ABS — and credit rating agencies that rate ABS — to provide investors with new disclosures about representations, warranties, and enforcement mechanisms. And, in April 2010, the Commission proposed rules that would revise the disclosure, reporting and offering process for ABS to better protect investors in the securitization market.

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires the Commission to adopt rules regarding the review of assets, such as loans, underlying the securities no later than 180 days after enactment.

|Educational Series, Legislation|

Spotlight on Foreign Corrupt Practices Act (FCPA) compliance

All U.S. firms seeking to do business in foreign markets must be familiar with the FCPA. Enacted in 1977 and amended several times since then, the FCPA generally states that if a foreign company has any footprint in the U.S., even simply wiring money through it, that company is subject to prosecution if involved in corrupt payments to foreign officials for the purpose of obtaining or keeping business.

The FCPA applies to any individual, firm, officer, director, employee, or agent of a firm and any stockholder acting on behalf of a firm. U.S. parent corporations also may be held liable for the acts of foreign subsidiaries where they authorized, directed, or controlled the activity in question, as can U.S. citizens or residents, who were employed by or acting on behalf of such foreign subsidiaries. The same provisions essentially extend to intermediaries which include joint venture partners or agents.

Between 2006 and 2009, the U.S. Department of Justice (DOJ) and the Securities and Exchange Commission (SEC), both of which have jurisdiction over the FCPA, initiated more enforcement actions than in the first 28 years of the FCPA’s existence. And the financial penalties for violations have skyrocketed. In December 2008, Siemens AG, Europe’s largest engineering firm, pleaded guilty to violating U.S. anti-corruption laws and was ordered to pay $1.6 billion to settle bribery charges in U.S. and Germany.

To ensure FCPA compliance, the DOJ recommends that companies exercise risk-based due diligence to ensure that they are doing business with reputable and qualified entities and representatives. The due diligence process, at minimum, should include investigating potential foreign representatives and joint venture partners to determine their general reputation and qualifications, whether they have personal or professional ties to the government, the reputation of their clients, and their history with the U.S. Embassy or Consulate, local bankers and other business associates. Additionally, the U.S. firm should be aware of “red flags,” i.e., unusual payment patterns or financial arrangements, indicators of corruption in the country or the particular industry, or refusal by the foreign joint venture partner or representative to provide certification that it will not engage in actions to further an unlawful offer, promise, or payment to a foreign public official and not cause the firm to be in violation of the FCPA (such as paying unusually high commissions, lacking transparency in expenses and accounting records, or retaining a joint venture partner or representative that has been referred by a government official.)

Capturing recent headlines are the changes to the FCPA-related compliance and ethics provisions of the Federal Sentencing Guidelines for Organizations that will become effective in November 2010. The amendments provide that a meaningful compliance program requires, among other actions, that when criminal conduct is detected, the company implement “reasonable steps to respond appropriately … to prevent further similar conduct.” An annotation to that provision specifies that the actions include “assessing the compliance and ethics program and making modifications necessary to ensure that the program is effective … and possibly including the use of an outside professional advisor to ensure adequate assessment and implementation of any modifications.”

The Guidelines also state that a board must be knowledgeable about the content and operation of the company’s compliance program and must “exercise reasonable oversight with respect to the implementation and effectiveness of its compliance and ethics.” Likewise, the DOJ’s prosecution guidelines consider whether the board exercises independent reviews of the compliance program and whether it is provided with information sufficient to enable the exercise of independent judgment. Directors have similar “Caremark” oversight duties arising under case law and various other directives, such as stock exchange rules, Sarbanes-Oxley, and audit committee charters.

|Educational Series, Legislation|

One of many case studies from our files that stopped a deal in its tracks

Our client, a commercial lender, requested background investigations of a consumer products company and its two principals in connection with their application for working capital financing. The loan officer was familiar with the subjects, and was astonished by the information that SI quickly uncovered. Searches of federal court records revealed a 2008 action filed against the subjects under the Federal Trade Commission Act for falsely advertising that using their electronic exercise belt caused weight and inch loss without exercise. The action was resolved by stipulated orders as part of a global settlement of both the FTC’s lawsuit and related actions brought by county and city prosecutors. The subjects and certain retailers collectively were ordered to pay over $2 million. The FTC and state orders further barred the defendants from making false advertising claims for the product or any similar device, and provided other injunctive relief to prevent future deceptive practices. And the subjects’ nefarious acts did not stop here. Both principals had several unpaid tax liens and judgments ranging in amounts from $48,000 to $650,000, and both were convicted within the last two years of driving under the influence of alcohol.

|Criminal Activity, Judgment, Taxes|

A look into money laundering

In U.S. law, money laundering is the process of engaging in financial transactions to conceal the identity, source, and/or destination of illegally gained money. It is believed that the term “money laundering” originated from the Mafia’s ownership of Laundromats whereby large sums of money were made through illegitimate activities that showed origination from a legitimate-appearing business.

The U.S. Criminal Code contains more than 100 predicate offenses to the crime of money laundering, which include drug trafficking, smuggling, prostitution rings, illegal arms sales, embezzlement, insider trading, bribery, and computer fraud. The Internal Revenue Service (IRS) considers money laundering a “tax evasion in progress.” And when no other crimes could be pinned to Al Capone, the IRS obtained a conviction for tax evasion. Leaving the courthouse, Capone said, “This is preposterous. You can’t tax illegal income!” Had the money laundering statutes been in effect in the 1930s, Capone also would have been charged with this crime. However, since October 1986, with the passage of the Money Laundering Control Act, organized crime members and many others have been convicted of both tax evasion and money laundering.

One of the most notable money laundering cases was settled in March of this year. Wachovia Bank, which is owned by Wells Fargo & Co., reached a $160 million settlement with the Justice Department over allegations that a failure in bank controls enabled drug traffickers to launder drug money by transferring $420 billion from Mexican currency-exchange houses to the bank. Under a deferred-prosecution agreement, Wachovia “admitted failure to identify, detect, and report suspicious transactions in third-party payment processor accounts.”

And money laundering has even reached the Vatican. Media reports from the past week say that the Vatican Bank, along with its chairman Ettore Gotti Tedeschi and director general, Paolo Cipriani, have been targeted for alleged violations of money laundering laws. Italian authorities temporarily froze 23 million euros ($30 million) from an account registered to the Institute for Works of Religion (IOR) a.k.a. the Vatican Bank. The investigation was opened after the Bank of Italy, adhering to anti-money-laundering directives issued by the European Union, alerted officials to two suspicious transfers on September 6, 2010. The Holy See expressed surprise at the allegations.

|Criminal Activity, Educational Series|

Decisions in two cases to set precedence for auditors’ fraud liability

It all started in 1905 with the lawsuit Smith v. London Assurance Corporation whereby an auditor was held liable for failing to audit its client’s branch office and detecting embezzlement.

Now more than 100 years later, the legal liability of auditors in detecting corporate fraud will be decided in two cases that were heard on Tuesday, September 14, 2010, in the New York Court of Appeals, potentially increasing the Big Four accountants’ exposure to multibillion-dollar shareholder lawsuits for malpractice. In both cases, the court will rule whether auditors can rely on the legal doctrine of in pari delicto (“in equal fault”) to reject claims for fraud allegedly committed by company insiders. The doctrine prevents someone from recovering damages from a defendant if that someone is also at fault. The argument is whether the shareholders, as owners of the company, can be held at fault for frauds committed within the company and barred from suing its auditors for not discovering the wrongdoing.

The first lawsuit facing scrutiny was filed by the shareholders of AIG against PricewaterhouseCoopers (PwC), the insurer’s auditor. The shareholders claim that PwC failed in its job as auditors in the early 2000s, when various AIG officers and directors, including ex-CEO Maurice Greenberg, allegedly engaged in fraudulent transactions to pad AIG’s bottom line. Authorities subsequently caught the fraud, and AIG had to restate years of financial statements that “eventually reduced stockholder equity by $3.5 billion.” AIG ended up paying more than $1.5 billion in fines, and the shareholders say that since PwC missed the fraud, they should be allowed to sue PwC for malpractice. The Chancery Court in Delaware dismissed their request to sue PwC, and the case was appealed in Delaware’s Supreme Court. That court asked the New York’s Court of Appeals to decide whether the shareholders have a claim under New York law.

The second case relates to protracted litigation by the bankruptcy trustee of Refco Inc., the failed futures broker, seeking damages from a number of the firm’s professional advisers, and auditors including Grant Thornton, KPMG LLP, Ernst & Young LLP, PricewaterhouseCoopers LLP, Mayer Brown, LLP, et al. The trustee alleges that Refco’s outside counsel Mayer Brown, and several other insiders are liable for defrauding Refco’s creditors by helping the defunct company conceal hundreds of millions of dollars in uncollectible debt. The U.S. Court of Appeals for the Second Circuit found that the trustee’s argument to revive claims against the corporate insiders raised unresolved questions concerning his standing under New York law to sue third-parties for Refco’s fraud.

|Fraud, Judgment|

Illinois Employee Credit Privacy Act (096-1426)

Effective January 1, 2011, the Act will prohibit employers, in many circumstances, from inquiring about or using an employee’s or prospective employee’s credit history as a basis for employment, recruitment, discharge, or compensation. The Act also will prohibit an employer from retaliating or discriminating against a person who files a complaint under the Act, participates in an investigation, proceeding or action concerning a violation of the Act, or opposes violation of the Act. Pursuant to the Act, an employer will not:

Fail or refuse to hire or recruit, discharge, or otherwise discriminate against an individual with respect to employment, compensation, term, condition, or privilege of employment because of the individual’s credit history or credit report.
Inquire about an applicant’s or employee’s credit history.
Order or obtain an applicant’s or employee’s credit report from a consumer reporting agency.

Exceptions to the Act are as follows:

State or federal law requires bonding or other security covering the individual holding the position.
Duties of the position include custody of or unsupervised access to cash or marketable assets valued at $2,500 or more.
Duties of the position include signatory power over business assets of over $100 or more per transaction.
Position is managerial, and involves setting the direction or control of the business.
Position involves access to personal or confidential information, financial information, trade secrets, or state or federal national security information.

The Act also states that nothing in its provisions shall prohibit employers from conducting a thorough background investigation which may include obtaining a consumer report and/or investigative report without information on credit history, as permitted by the Fair Credit Reporting Act (FCRA).

|Educational Series, Employment Decisions, Legislation|

The FCRA and Employer’s Obligations

In recent years, negligent hiring and retention lawsuits have seen a dramatic rise, with settlement payouts averaging over a million dollars. These cases are predicated on the theory that an employer may be held liable for its negligence in placing a person with certain known propensities for criminal or other unfit behavior in an employment position where the individual poses a threat to others. The most common defense against negligent hiring or retention actions is based on foreseeability, which is often determined through a background investigation. Some courts have been more flexible than others in damage awards, but regardless of their stance, the closer the connection between the perpetrator’s dangerous propensity and the actual tortious conduct, the stronger the case against the employer. The law in both negligent hiring and negligent retention also recognizes that a company’s duty to avoid employing dangerous people does not end when an individual is hired–it extends to negligent supervision, negligent training and negligent firing.

Nearly every investigation that touches on employment is covered by the Fair Credit Reporting Act (FCRA), which defines employment (purposes) as “evaluating a consumer for employment, promotion, reassignment or retention as an employee.” If an employer uses a third party screening service to conduct a background investigation of an applicant or employee, that company is considered a “consumer reporting agency” (CRA) under the FCRA. The CRA’s reports, known as consumer reports, may contain information from educational institutions, professional licensing boards, former employers, courts, credit bureaus, references, motor vehicle departments, regulatory entities, media sources, etc.

The FCRA is a complex federal statute that has been significantly revised since 1970. But the Act’s primary mandate remains that CRAs adhere to “reasonable procedures” to protect the confidentiality, accuracy, and relevance of consumer information. Under its Fair Information Practices, the FCRA has established rules concerning personal information that include rights of data quality (to access, dispute and correct), data security, usage limitations, data destruction, disclosures, user consent, and accountability. The FCRA requires the employer/user to affirm to the CRA that it is in compliance (with FCRA) and has enacted the following directives prior to the initiation of a consumer report:

Verified that there is a legitimate need for requesting a consumer report
Certified that written permission was obtained from the applicant or employee and proper disclosures were provided
Stated the reason for requesting a consumer report
Certified that the information will be used for employment purposes only.

Before any adverse action is taken based on information in the consumer report, the FCRA obligates the employer to provide the applicant or employee a copy of the report and summary of consumer rights prescribed by the FCRA. And if adverse action is taken, the employer must deliver an “adverse action notice” to the affected individual. Further, the employer must certify that it will not use any information from a consumer report in violation of the applicable federal or state equal opportunity laws and regulations.

The FCRA makes a distinction between a “consumer report” and “investigative consumer report.” Its delineation of a “consumer report” is that it is comprised of verifications of facts about education, employment or other claims made by the applicant, while an “investigative consumer report” is a compilation of information about character, general reputation, personal characteristics, or mode of living through interviews. Thus, an employer who uses investigative consumer reports must comply with the provisions of the FCRA that apply generally to consumer reports as well as the provisions that are specific to investigative consumer reports which include “clearly and accurately” disclosing in writing that it may obtain the aforementioned information. This notice must contain a statement advising the individual of the right to request additional disclosures concerning the nature and scope of the inquiry, along with a written summary of consumer rights. Also, for an investigative consumer report, the disclosure must be made within three days after such report is requested, while in a consumer report, notice must be given before the report is procured.

The FCRA rules also apply when an employer uses a third party to investigate employee misconduct. The employee must be notified “clearly and conspicuously” and authorize, in writing, the undertaking of an investigative consumer report. If the employer disciplines or adversely treats the employee based upon the information in the report, the employer must provide the employee, within 60 days of the adverse decision, the following:

Notice of the disciplinary action
Name, address and telephone phone number of third party that prepared the report
Statement that said third party had no input into the decision to discipline the employee and thus will not provide information about the action taken
Notice that the employee is entitled to a free copy of the report and can request that the employer state the reason for the disciplinary action.

The FCRA does not apply to investigations of misconduct conducted by internal personnel or by third parties which do not regularly prepare such reports.

Violations of the FCRA can lead to civil and/or criminal penalties for the CRA and the employer. Civil penalties may carry nominal damages (up to one thousand dollars if no actual damages exist), actual and punitive damages, and attorneys’ fees and costs, if there is “willful noncompliance.” Civil penalties for “negligent noncompliance” are confined to actual damages and attorneys’ fees and costs. Criminal penalties may be imposed when a party knowingly and willfully obtains information from a CRA under false pretenses.

Establishing a relationship with a reputable CRA is one of the best assurances of FCRA compliance. An experienced company can provide guidance not just in the legal process of the FCRA, but also instill trust that it has met its related obligations.

|Educational Series, Employment Decisions, Legislation|

Fake your way into a dream job for under $60

The job market is tight and fake-your-career services are in bloom. Buy a Job Reference, which describes itself as a “shameless service,” boasts that in the first six months of 2010, it assisted nearly 400 clients in gaining employment (but links to success stories do not work so maybe the stories are fake too.) For the low price of $59.99, payable through credit cards and PayPal, the company will supply a personalized fake employer name, phone number and address, suitable for any occupation you choose. And if you need a new apartment to go with that new job, for $29.99 the company will set you up with glowing previous landlord references.

CareerExcuse.com, a self-proclaimed “world’s largest network of job reference providers” since July 2009, is more expensive with a $65 set-up fee plus an undisclosed amount for a 30-day answering service, and a $20 monthly subscription. This basic package includes a “professional voicemail system that many banks and large companies use, calls that are returned from voicemail within 24 hours armed with positive references provided by you, and a toll-free number and e-mail addresses for your references.” If you really want to impress a prospective employer, there is a premium plan for $195+ that will upgrade the verifications to a live receptionist. But once you land that dream job, most likely you will have to wait a while before you accrue any paid time off. Guess what? For $35 you can get some bereavement days with CareerExcuse operators standing by to verify that your designated relative is deceased, and avail a real funeral home Web site and address for flower delivery. CareerExcuse apparently wants to be a one-stop shop for all your fibbing needs, as it also provides links to instant “real university degrees.”

According to several Internet sources, including ABCNews.com, Alibi HQ also is or has been in the fake reference business; however, its Web site address, www.alibihq.com, leads only to a spam-type search page. ABCNews.com said in its August 2009 article that Alibi HQ charges $199 for the first 90 days and $50 for each additional month for the fictitious declarations. Mark Stevens, a purported Alibi HQ spokesman, told ABCNews.com that the company, which also offers fake landlord references and fake doctor’s notes, has been operating for several years, and that customer interest in employment references has skyrocketed over the last year (2009) with calls from people seeking Alibi HQ’s services quadrupling.

So how do these companies get away with such slippery handicraft? Each claims that it will not do anything that defies the law, including providing references for loan purposes. CareerExcuse contends that in a segment by KENS-5 in San Antonio, the Better Business Bureau did not question the legality of its services, although it did not give the company a “ringing” endorsement. But legal experts say that such companies and the clients they serve may ultimately find themselves as defendants in lawsuits filed by duped employers.

|Educational Series, Employment Decisions, Fraud|

FTC proposes changes to improve credit reporting notices

The Federal Trade Commission announced on August 16, 2010 that it is proposing revisions to the notices that consumer reporting agencies provide to consumers, and to users and furnishers of credit report information under the Fair Credit Reporting Act (FCRA). The FCRA requires the FTC to publish model notices for several forms that must be provided by consumer reporting agencies. The proposed changes are designed to reflect new rules that the FTC and other financial regulators have enacted under the Fair and Accurate Credit Transactions Act of 2003, and to make the notices more useful and easier to understand.

In addition to revising the general Summary of Rights notice, which informs consumers about their FCRA rights, such as how to obtain a free credit report and dispute inaccurate information, the FTC is proposing improvements to the notices that credit

reporting agencies provide to users and furnishers of credit report information.

The FTC is accepting public comments on the proposed changes until September 21, 2010.

(The FTC contact is Pavneet Singh, Bureau of Consumer Protection, at 202-326-2252.) See http://www.ftc.gov/os/fedreg/2010/august/100816fcranotice.pdf for the full text of the proposed revisions.

|Educational Series, Legislation|

Belford University: another diploma mill case from our files

So why did the applicant for a professional level position with one of our clients choose Belford University in Humble, Texas to get a Bachelor of Science degree in accounting? Maybe because Belford grants original degrees printed on traditional degree paper with a gold-plated seal which identifies it as a degree from a reputed and reliable institution. Or perhaps because the university offers free three-day shipping on a complete $249 degree package (a 4.0 GPA is $75 extra), consisting of one original accredited degree, two original transcripts, one award for excellence, one certificate of distinction, one certificate of membership and four education verification letters. We will never know for sure. But we do know that the university’s claims on its two Web sites (www.belforduniversity.net and www.belforduniversity.org) of being “an accredited institution recognized by two renowned accreditation agencies for on-line education, namely the International Accreditation Agency for Online Universities (IAAOU) and Universal Council for Online Education Accreditation (UCOEA)” are meaningless as the accreditations are not approved by the U.S. Department of Education. It is a bit suspicious too that on its “.org” site, the links to “University Briefs” are inactive, and thus we cannot find out the details of Belford’s “Clair’s Award for Excellence” and why Clair (spelled without an “e”) is giving out awards.

The Houston Press got on Belford’s haft in 2006 when it exposed the institution as a degree mill, operating from Humble, Texas with an indeed humble office (so humble that it’s non-existent as someone closed its account at the USA 2ME mailbox drop.) An entry in the Wikipedia stated that the degrees are actually mailed from the United Arab Emirates. The Houston Press checked out some of the names of Belford’s professors and its distinguished alums, which include Michael Fonseca, who was “promoted to the post of Divisional Head for Romuna Securities, a subsidiary of Romuna Group.” But the impressive-sounding Romuna appears to have its empire only in the mirage of Belford University.

David Linkletter of the Texas Higher Education Coordinating Board said that the board reported Belford to the state Attorney General’s office in March 2006, noting that “this is not a legitimate institute of higher education, as no legitimate university offers a complete degree on the basis of one’s life experience…To the extent that Belford University is in Texas, it is operating in violation of the Texas Education Code.” Since September 2005, the code makes it illegal to use a fraudulent or substandard degree for purposes of employment, business promotion or to seek admission to a university.

Despite Belford’s history of bamboozlement, as many as 500 resumes in LinkedIn, including those of a New York-based director of human resources and a CEO in the pharmaceutical industry, boast degrees from this university, according to a February 2010 post on a “consumer ally” Web site.

|Educational Series, Employment Decisions, Fraud|

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