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Chief Compliance Officer Stole Employee Information to Bid at Auctions

FINRA barred a Chief Compliance Officer for using his access to confidential employee records to create false online bidding accounts at auction houses. The respondent, who also served as the firm’s president, used his access as CCO to obtain employees’ driver’s license and passport information to impersonate those employees so that he could bid and acquire auction items. The auction houses had previously banned him because he successfully bid on items and did not pay for them.

The Chief Compliance Officer has extraordinary (and in some cases, unwarranted) access to employee records in addition to other confidential information such as executive meetings and emails. Firms should pursue enhanced background due diligence on potential CCO candidates, create information barriers so that the CCO does not have access to non-regulatory information, and implement a supervisory structure that ensures CCO accountability. Alternatively, consider outsourcing to a third-party firm that has limited access to firm systems as well as direct legal liability for breaches of confidentiality.

The Friday List: 10 Reasons Outsourcing Compliance Beats Hiring an In-House Chief Compliance Officer

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. 

Over the last several years, an increasing number of investment management firms have chosen to outsource the Chief Compliance Officer role and associated compliance function.  In our experience, these firms make this decision for rational business reasons based on an assessment that outsourcing the compliance function is better than hiring a full-time employee.  Usually, firms consider outsourcing because of an external event such as a less-than-perfect SEC exam or an institutional due diligence process that suggests unknown weaknesses.  Some firms decide to outsource after yet another internal CCO changes jobs.  Other times, firm management simply gets frustrated with the inherent limitations of the one internal compliance person.  Regardless, we list below the top 10 reasons investment firms should outsource the CCO role and compliance function rather than hire an in-house employee.

10 Reasons Outsourcing Compliance Beats Hiring an In-House CCO

  1. Experience: A team of professionals can draw on decades of aggregate compliance experience to address a firm’s regulatory challenges.
  2. Knowledge: No one person can provide the depth of knowledge of several compliance professionals working collaboratively. 
  3. Independence: A third party firm offers investors and other stakeholders an independent assessment of a firm’s compliance strengths and weaknesses.
  4. Industry best practices: A multi-person team working with multiple clients across the country has the industry vision to inform the compliance program.
  5. Accountability: A compliance firm stands behind its work and advice with a service level agreement and professional liability insurance. 
  6. 24/7/365 support: A person may take PTO, but a team of professionals is available at all times for any emergency including unplanned client due diligence and SEC exams.
  7. Personal liability: Serving as CCO involves significant personal liability, which is better left to professionals that understand and accept the regulatory and career implications. 
  8. Frees up internal resources: Internal personnel can focus on core activities such as portfolio management and fund-raising.   
  9. Management: Senior managers can avoid the confusing and time-consuming process of hiring, retaining, and managing an internal CCO, only to start the process anew in the event the CCO leaves. 
  10. Cost savings: Because of program efficiencies, outsourcing generally costs less than hiring a full-time employee. 

Emerging Hedge Funds Spend 20% on Compliance but Could Save Through Outsourcing

A survey conducted by AIMA (Alternative Investment Management Association) and prime broker GPP reports that emerging hedge funds spend 20% of fees on compliance and regulation but could be outsourcing more to help profitability.  The survey of hedge fund managers with less than $500 Million in AUM finds that “almost 90% of respondents” allocate “up to one-fifth of their total expenditure to compliance, with this number expected to increase when firms adhere to MiFID II.”  The report argues that firms should be outsourcing more functions, including compliance, because asset allocators are much more concerned about the pedigree of a firm’s service providers than a its outsourcing practices.  The survey data shows that smaller firms can become profitable at less than $100 Million in AUM, contradicting commonly held beliefs about scale.

OUR TAKE: Back in 2013, a KPMG study reported that global hedge fund firms spend 7% on regulatory compliance (which we believe is about 5% of total revenue).  This latest AIMA/GPP survey shows that smaller firms pay a greater percentage and that the regulatory burden continues to increase.  As allocators focus more on service providers than outsourcing, investment firms should consider outsourcing compliance to a more efficient third party resource and focus on the core business of raising and managing assets.


Sell-Side Firms Fear Regulations but Fail to Spend on Necessary Compliance Outsourcing


A survey of over 400 sell-side executives (broker-dealers, investment bankers, commercial bankers) by FIS, a financial technology provider, reports that compliance has become a major concern that could be addressed with outsourcing, but sell-side firms are postponing compliance spending.  Survey results indicate that 77% of respondents expect regulation to “severely impact their business” over the next 24 months, but only 12% intend to invest more in regulatory compliance.  At the same time, 51% of respondents recognize the industry trend toward outsourcing, especially in traditional back-office functions such as compliance.  FIS maintains that “outsourcing may gradually permit back-office staff to shift towards managing technical projects and away from daily administrative tasks, helping firms to meet specific compliance requirements.”  Craig Costigan, division executive, Risk, Compliance and Global Securities, FIS, explained the disconnect: “They’re kicking the cans down the road, and they’re putting it off because it never fits into this year’s budget.”

OUR TAKE: Regulators don’t assess whether regulatory requirements fit into this year’s budget or how it affects the bottom line.  Outsourcing back office functions such as compliance allows firms to best leverage their compliance resources to ensure regulatory compliance without blowing the budget.


Compliance Outsourcing Has Doubled in Last 3 Years


A recent survey of registered investment advisers sponsored by WealthManagement.com and LPL Financial reports a significant increase in the number of firms outsourcing compliance and other non-revenue generating functions.  The percentage of firms outsourcing compliance has doubled over the last 3 years.  Nearly 1 in 5 RIAs now outsource compliance, a function deemed to be “necessary, but behind-the-scene activit[y] with less direct linkage to the customer experience.”  Other often-outsourced activities include HR, taxes, and bookkeeping, as advisors become more “focused on the activities that are most critical to their businesses” while “it is getting increasingly efficient to outsource those functions less important to growth and client satisfaction.”

OUR TAKE: Outsourcing compliance has become an accepted practice especially for advisers that don’t have the resources to hire and retain internal compliance talent.  A third party firm brings on-demand knowledge, scale, depth, experience, and independence.