Today, we offer our “Friday List,” an occasional feature summarizing a topic significant to investment management professionals interested in regulatory issues. Our Friday Lists are an expanded “Our Take” on a particular subject, offering our unique (and sometimes controversial) perspective on an industry topic.
Many investment managers and boards struggle with the factors to consider when retaining a compliance consulting firm. They mistakenly assume that all compliance firms are the same. However, much like hiring any other professional service that seems inscrutable, compliance services firms can be analyzed by specific and objective characteristics. Below, we offer some guidance on how to evaluate a compliance consultant. Also, we offer a form of RFP for retaining a compliance consulting firm.
10 Factors for Hiring a Compliance Consulting Firm
Size: The sheer size of the firm makes a difference. A firm with more than 10 consultants will offer more knowledge, experience, depth, and services than a firm of 1-5 people.
Employee Experience: Is the firm hiring senior professionals or newbies? Do they focus on former regulators or experienced business people? Is there a hiring philosophy that you can rely on, or are you just hiring the person in front of you rather than the firm? Employee turnover is a fact of life, so make sure you hire a firm that will offer consistency notwithstanding a particular employee.
Services: Some firms offer holistic, ongoing services that may include providing a chief compliance officer. Some firms only provide mock audits. Inquire what the firm provides most of its clients. Also, ask about the testing program. How much time does the firm spend on testing activities? What does the report look like? Does the firm conduct interviews, review documents, engage in forensic testing, and sampling?
Clients: Does the firm provide services to your industry? The investment management industry includes mutual fund managers, private equity firms, institutional money managers, family offices, and fintech companies. Does the compliance consultant have the relevant experience? How many clients does the firm serve?
SEC Exam Experience: Don’t assume that every compliance consultant has actually managed an SEC exam. Also, ask about results. Most reputable firms will not guarantee a perfect exam, but an experienced firm should be able to describe how it improved possible outcomes.
Service Model: Compliance consulting is a professional service. Does the firm offer just one person or a team (which softens the impact of turnover)? Will they engage proactively without you calling first? Will they charge for every interaction (like a law firm)? How often will they come on-site?
Client Turnover: This can be a red flag if a firm has experienced significant client turnover. It is always a good idea to ask to speak to a former client as well as a longstanding client.
Ownership: Is the firm employee-owned or part of a large organization? Is there up-the-ladder accountability? Does the firm have other businesses (fund administration, accounting, brokerage) that could divert attention?
Tenure: Firms that have been in business more than 5 or 10 years have a demonstrated track record that shows success and continuity. New consultants may be figuring out their business model, filling time between jobs, or auditioning for a job at your firm.
Insurance Coverage: Shockingly, many compliance consultants do not carry E&O or professional liability coverage. We recommend a minimum of $1 Million in coverage.
A jury awarded a terminated General Counsel $2.9 Million in compensatory damages and $5 Million in punitive damages for wrongful termination due to his whistleblower activities. In a key ruling, the Court (USDC for Northern District of California) ruled not to exclude evidence provided by the GC that his former employer claimed was privileged under California professional rules. The Court held that federal law preempted the more stringent state law and that federal common law governing privilege applied to his Sarbanes-Oxley Act whistleblower retaliation claim. The GC had raised Foreign Corrupt Practices Act compliance concerns.
OUR TAKE: While we sympathize with the plaintiff in this case, the broader policy of piercing lawyer-client privilege may result in limiting the role of in-house counsel. Because the court can discard privilege, senior management and outside counsel may be less likely to include in-house lawyers in more sensitive matters.
“I’m so glad I live in a world where there are Octobers.” (L.M. Montgomery, Anne of Green Gables)
Welcome to the October 2016 BOTW. Who doesn’t love October: changing leaves, pumpkin-spiced lattes, football? The regulatory world is also experiencing its own transitions. SIFMA addresses the consequences of financial regulation, Dechert offers advice on private equity compliance, and K&L Gates explains auditor independence. For those with an interest, check out BBD’s piece on mutual fund accounting and Thompson Hine’s overview of the new liquidity risk management rules.
The Intended and Unintended Consequences for End Users of Post-Crisis Financial Regulation (SIFMA)
The SEC’s Office of Compliance Inspections and Examinations has launched a “Supervision Initiative” to examine supervision practices of investment advisers that employ previously-disciplined advisers or brokers. OCIE will focus on a firm’s compliance practices including its policies and procedures for hiring, reporting, oversight, and complaint handling. The staff will also review disclosures, conflicts of interest, and marketing materials. The Supervision Initiative cites a recent study concluding that reps with a disciplinary history are 5 times more likely to engage in misconduct (See http://cipperman.com/2016/03/04/academic-study-reports-widespread-financial-adviser-misconduct/.)
OUR TAKE: The SEC wants to discourage firms from hiring disciplined advisers and brokers. This sweep puts the burden on such hiring firms to prove that they can prevent future violations.