Funds & Advisers
The SEC hosted its annual CCOutreach National Seminar in Washington D.C. on January 26, 2010. We listened to all of the sessions and have summarized below the matters discussed which may be of particular interest to our adviser and fund clients.
Unlike previous CCOutreach seminars, this yearís seminar combined presentations for Chief Compliance Officers (CCOs) of investment advisers, investment companies and broker-dealers. The seminars were presented in several sessions with panelists consisting of SEC and FINRA regulators from various regional offices, as well as CCOs from JP Morgan Securities, Fidelity, TD Ameritrade and ClearBridge Advisors.
There were several common themes throughout the day-long seminar. Following the Madoff debacle, it is no surprise that many of these areas find their roots in fraud detection:
In the wake of the SECís failure to detect the Madoff Ponzi scheme and with the December 2009 finalization of the SECís amendments to the Custody Rule (as reported in our 12/30/09 Compliance Alert), it is apparent regulators consider third-party asset verification a significant area of focus for 2010. The SEC has been very clear about its intention to possibly contact advisersí clients directly through written correspondence or phone calls to confirm assets as part of the examination process.
We noted the SEC staffís awareness and understanding of the concerns advisers have regarding the SEC contacting clients directly. If a firm is subject to an examination, advisers may want to address potential client concerns by educating clients about the possibility the SEC may contact them. Advisers could provide clients with a copy of the SECís Office of Compliance Inspections and Examinations (OCIE) letter, which states the SEC contact should ďin no way be construed, in an of itself, as an indication of any problem or irregularityĒ by the adviser.
Another hot topic at this yearís seminar was Risk Management. Apart from the SECís assurance that exams will be much more risk-focused, it also appears examiners may broaden the scope of their exams to include the organization as a whole, rather than just focusing on its compliance policies and procedures. SEC staff advised firms to implement risk assessment processes as examiners will be reviewing how firms are managing the inherit risks associated with their businesses and the ways those risks and conflicts are being disclosed to clients and shareholders.
Risk Management encompasses all business functions and how each contributes to the firmís overall risk profile. If we take the SEC at its word, we will see an increased focus by the regulators on firm-wide Risk Management programs in the near future. Therefore, inaction is your biggest enemy. If there is no existing formal oversight structure, create a committee or working group to routinely meet and discuss the risks for each respective area of the business. While we often see firms identify the CCO as the leader of these committees, the more logical choice may be the COO or the CFO. A firmís size will most likely dictate the structure of its Risk Management team. For example, smaller firms may not be able to separate the Compliance and Risk Management functions.
Insider trading continues to be an area of SEC scrutiny. In her opening address, SEC Chairman Mary Schapiro identified the CCO as the firmís first line of defense. Some of the best practices discussed at the seminar included the use of conflicts questionnaires to identify and monitor potential risks, initial and on-going education of staff on the firmís policies and procedures, reviewing and monitoring employeesí personal trades in an effort to detect any questionable patterns, and requiring investment team members to track communications with company management. Some firms have instituted mandatory vacation policies to curb potential insider trading activities as well; however, panelists agreed these policies can not be effective unless a firm commits to enforcing these policies with no exceptions.
Suggestions for forensic tests included reviewing employeesí electronic communications, reviewing the timing of announcements against firm trading and the personal trading of staff, and monitoring travel and entertainment expenses along with the timing of employeeís meetings with company management and personal trading.
In light of the current market environment and the accessibility of material non-public information, insider trading will continue to be a high focus area for the SEC. Firms should consider putting additional programs in place to train staff, clearly outline the expectations of the firm, and monitor and test for potential infractions.
Administering Compliance Ė CCO Responsibilities
Several of the panel discussions centered on the regulatorsí expectations of a firmís compliance program and the responsibilities of CCOs, now that the Compliance Rule has been in effect for five years. SEC regulators indicated there are higher expectations for firms to have comprehensive compliance programs in place, including policies and procedures around the monitoring and testing of the various facets of the firmís compliance program. Therefore, firms should ensure they are routinely testing and monitoring the efficiency of their compliance programs. The SEC acknowledged the role of the CCO is a difficult one and Senior Management has to support the compliance program for it to work effectively. The firm has to work in concert with the CCO in an effort to ensure clients are treated fairly; there is transparency around the firm practices and those practices are disclosed; and compliance and business risks, along with conflicts of interest, are identified, addressed and disclosed.
Focus of 2010 Regulatory Examinations
Both the SEC and FINRA indicated they are going to be on the lookout for fraud in all aspects of a firmís business practices during their 2010 examinations. The current economic environment is a continuing concern of regulators, as there may be a greater potential for firms in this difficult market environment to take on more risk in an attempt to boost performance. The following are some of the key focus areas identified during the CCOutreach; however, this list is not inclusive of all potential areas the regulators may review during examinations:
Chairman Schapiro stated the SEC is strengthening the integration of oversight and enforcement of dually registered advisers and broker-dealers. These examinations will be conducted by one focused team, which will include examiners with both broker-dealer and advisory experience. Examiners will focus on conflicts, sales of each otherís products, custody by affiliates, outside business activities and asset verification.
- The compliance culture of the firm, ensuring there is supervision, and the firm is doing what is stated in its policies, procedures and disclosures.
- A review of the firmís overall assets, revenues and the factors attributable to any significant declines.
- The firmís valuation processes; have the firmís valuation processes evolved due to changes in the market and do the firmís procedures take into account any difficult to value securities?
- A review of the firmís trading practices and the policies and procedures in place, and even more importantly how the firm is monitoring and conducting testing around trading practices, such as: high frequency trading, ETFs, soft dollar arrangements, directed trading, best execution and consideration of alternative trading venues. Gene Gohlke, Associate Director of the OCIE, said regulators expect firms to conduct back-testing and forensic testing in an effort to obtain assurances trading is following the policies and procedures of the firm and striving for best execution.
- Mutual fund and hedge fund redemptions Ė how are they handled?
- The policies and procedures the firm has in place to monitor access personís transactions and review for possible insider trading or other market manipulation practices.
Carlo di Florio, the new Director of OCIE, said he expected the SEC would include some of the best practices identified during the seminar on the SECís website, possibly as Compliance Alerts.
We hope this information is helpful to you. As always, we welcome your questions and feedback.