Home » Compliance Blog » compliance

Tag: compliance

Public Company Fined for Operating as Inadvertent Investment Company

The SEC fined and censured a public company for failing to register as an investment company because over 80% of its assets consisted in non-controlling interests in other OTC companies.  The respondent changed business direction in 2014 and began purchasing OTC and private interests in marijuana related businesses, which came to represent more than 80% of its assets.  In 2015, the company could not respond to SEC requests about investment company registration, which is required when investment securities exceed 40% of total assets.  As a public company, the respondent could not rely on private offering exemptions (3(c)(1) or 3(c)(7)).  As part of the settlement, the company agreed to register or pay a $5000 penalty for each month that the company failed to register.

OUR TAKE: Operating companies engaged in passive investing, which often occurs in emerging industries, must be aware of becoming an inadvertent investment company.  Once total investment securities exceed about one-quarter of total assets, it’s time to consult a 1940 Act lawyer.

https://www.sec.gov/litigation/admin/2017/ic-32840.pdf

RIA’s Affiliate Private Fund Manager Wrongly Claimed Registration Exemption

The SEC censured and fined a fund manager and its principal and barred the principal from serving as a chief compliance officer for incorrectly claiming exemption from Advisers Act registration and its requirements.  The SEC contends that the principal, which managed a registered investment adviser, created an affiliate to manage two private funds and then claimed an exemption from registration because the funds had less than $150 Million.  The SEC maintains that the affiliate was required to register because it was under common control with the registered adviser and shared office space, employees and technology.  The SEC alleges that the private fund adviser hoped to avoid the custody rule’s audit requirements and compliance requirements.  The SEC cites Section 208(d) of the Advisers Act, which prohibits a person from doing indirectly any act which would be unlawful if done directly.

OUR TAKE: This case has significant implications for larger organizations.  If a firm operates a registered investment adviser affiliate, the SEC, based on this action’s reasoning, would prohibit the firm from claiming an exemption registration for an unregistered fund manager under the same roof.  The SEC is using the regulatory flexibility to integrate advisers under one Form ADV as a regulatory weapon to force registration on otherwise exempt affiliates.

 https://www.sec.gov/litigation/admin/2017/ia-4733.pdf

The Friday List: 10 Ways Compliance Contributes to Firm Value

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.

Senior executives may view spending on compliance as a necessary evil or a cost of doing business.  While compliance spending is certainly necessary and a cost, the compliance function, properly structured and implemented, can significantly contribute to a firm’s value.  We believe the added value can actually exceed the cost, and compliance spending can be viewed more broadly as an investment in the business.  So, for today’s list, we offer 10 ways that compliance contributes to firm value.

 

10 Ways Compliance Contributes to Firm Value

 

  1. Avoid Fines and Penalties:  All firms want to avoid the punitive and unplanned fines, penalties, and disgorgement associated with enforcement actions that a good compliance program can prevent.
  2. Protect Individual Reputations:  The SEC names a corporate officer in over 80% of enforcement actions.  Your name in an enforcement action could be career-ending, especially if you are barred from the industry.
  3. Attract Institutional Clients: Most institutional investors conduct Operational Due Diligence that includes an in-depth review of the compliance program.  A weak compliance program can disqualify a firm regardless of investment performance history.
  4. Increase Firm Multiple: Potential acquirers will assess a firm’s compliance program as a factor in the multiple offered.  An inadequate compliance program means more risk, and more risk means a lower multiple.
  5. Improve Operations:  Very often, the compliance procedures serve as a starting point for operational and desk procedures.  Also, the discipline of drafting and implementing procedures will serve as an example for finance, portfolio management, and product development.
  6. Reduce Executive Time:  Fewer compliance problems and the associated decline in operational problems means less time spent by executives dealing with non-productive headaches.
  7. Lower Legal Expenses:  A good compliance function will reduce the number of questions requiring outside counsel.  Firms will incur significant legal expenses when confronted with an avoidable enforcement action.
  8. Preserve Reputation:  An enforcement action undermines a firm’s reputation, the most valuable asset of any investment management firm.  Blue chip firms like to do business with other blue chip firms that have a reputation for integrity.
  9. Attract Employees: A quality compliance program will create a credible firm attractive to quality employees.  A “cowboy culture” will repel the top-notch employees needed to grow into an institutional franchise.
  10. Freedom from Fear:  You wouldn’t drive a car without good brakes.  Just like good brakes, a good compliance program allows firm management to move fast and seek new opportunities without fear of an unknown regulatory breakdown.

SEC Staff Publishes 2017 Exam Priorities

priorities II

The staff of the SEC’s Office of Compliance Inspections and Examinations has released the 2017 Examination Priorities, which focus on retail investment products, retirement advice, FINRA supervision, and private funds.  The staff’s retail initiatives will include a focus on robo-advisers (compliance programs, suitability, data protection); wrap programs (suitability, trading away), ETFs (exemptive relief compliance, creation/redemption processes), and newly-registered advisers.  As part of its emphasis on retirement products, the SEC will scrutinize variable insurance and target date funds and assess how pension plan advisers satisfy their fiduciary obligations.  The staff will continue to target private fund advisers and cybersecurity.  As part of its obligation to assess market-wide risks, OCIE will enhance oversight of FINRA, including assessing the quality of broker-dealer exams.  OCIE’s Director advised registrants to “evaluate their own compliance programs in these important areas and make necessary changes and enhancements.”

OUR TAKE: Many of these areas – wrap, ETFs, variable insurance, target date funds, cybersecurity – continue longstanding initiatives.  Others – robos, private advisers, FINRA – are more recent regulatory objectives.  Compliance officers should use this exam priorities letter as a tool to upgrade their own compliance programs.

https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2017.pdf

SEC Chief of Staff Outlines Compliance Challenges

rolling-ball-uphill

SEC Chief of Staff Andrew (Buddy) Donohue recently described the future challenges facing compliance officers.  Mr. Donohue expressed concern about shrinking top-line growth in the asset management industry that could compromise the ability of compliance officers to obtain the funding necessary to implement the compliance program.  He also questioned the emerging trend of compliance taking a more active role to ensure compliance rather than assisting in identifying regulatory issues and developing policies and procedures.  Mr. Donohue warned that compliance must be viewed as a partner, not a “scapegoat or cost center.”  Mr. Donohue also inventoried the ever-expanding knowledge required including laws of multiple jurisdictions, overlapping statutes, and new technologies.  He advised compliance officers: “It is critical that you make it a priority to develop the necessary technical expertise, keep up with changing market dynamics, fully appreciate all of the firm’s businesses and follow regulatory developments and their impact on your firm and its operations.”  Despite his comments, Mr. Donohue expressed hope that his comments won’t “scare you away from a career in compliance.”

OUR TAKE: With over 40 years’ industry and regulatory experience, Mr. Donohue is a respected voice on regulatory and compliance issues.  Every CEO and Board should read this speech and ask whether their CCOs have the attention and resources to meet these challenges.

https://www.sec.gov/news/speech/remarks-at-the-national-society-of-compliance-professionals-2016.html

Hedge Fund Firm and Senior Manager Failed to Supervise Analyst Convicted of Insider Trading

failure-to-supervise

A hedge fund firm agreed to pay nearly $9 Million in disgorgement, interest and penalties and a senior research analyst was fined and barred from the industry for failing to reasonably supervise an analyst convicted of insider trading.  The SEC alleges that the firm and the supervisor ignored red flags including receiving confidential information that preceded public announcements, allowing the analyst to work out of his home, and the absence of any documentary support for recommendations.  Moreover, the supervisor violated the firm’s policies by failing to report the red flags to the firm’s Chief Compliance Officer for further investigation and testing.  The SEC asserts that the firm should have implemented heightened supervision including requiring reporting conversations with employees of public companies, requiring heightened information, and tracking recommendations.

OUR TAKE: The SEC properly placed responsibility on the firm and its line management (and not the CCO) for failing to supervise and report concerns to the CCO for further investigation.  Management should have accountability for regulatory compliance, while the compliance department owns the drafting and testing of procedures and advising management on regulatory issues.

https://www.sec.gov/litigation/admin/2016/ia-4550.pdf

Compliance Outsourcing Has Doubled in Last 3 Years

outsourcing

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.

https://www.wealthforge.com/hubfs/WM-2016-RIA-Trend-Report.pdf?t=1476715934334

SEC Adopts Liquidity Risk Management Program Rule

liquidity

The SEC has adopted a new rule requiring open-end registered funds to establish liquidity risk management programs.  New Rule 22e-4 will require registered funds to implement a program that assesses liquidity risk, classify securities into one of four liquidity categories, set a liquidity minimum, and report violations of overall portfolio illiquidity limits.  The liquidity risk program also requires Board oversight including the designation of a fund officer to administer the program.  The SEC also adopted new monthly portfolio disclosure rules for registered funds as well as a rule allowing funds to use swing pricing.  Fund complexes with more than $1 Billion in net assets must comply with the liquidity risk management rule by December 1, 2018.

OUR TAKE: The new rules will require a great deal of additional work for the folks in operations, legal and compliance.  The Oper-Pros will need to figure out how to pull and classify the data.  The lawyers will have to create additional disclosures.  And, the Compli-Pros will likely be the appointed officers to administer the programs.

https://www.sec.gov/news/pressrelease/2016-215.html

Adviser Agrees to Hire Experienced CCO to Settle Compliance Charges

next-exit

The SEC fined and censured an investment adviser and its president/CIO for failing to implement compliance policies and procedures after the SEC noted principal transaction and best execution deficiencies during 2 separate exams.  As part of the settlement, the respondent agreed to hire an experienced chief compliance officer and retain an independent compliance consultant.  The SEC alleged that the respondent promised, but failed, to implement required principal transaction and best execution policies following SEC exams in 2006 and 2009.  Even though the firm adopted policies and procedures, the SEC maintains that the firm violated those policies by continuing to engage in unlawful principal transactions and failing to monitor best execution.

OUR TAKE: Investment firms must hire a competent, experienced, and fully-engaged chief compliance officer to maintain and implement the compliance policies and procedures.  The SEC will not accept mere lip service when it comes to regulatory compliance, especially when a firm does not follow through on specific undertakings made in response to deficiency letters.

https://www.sec.gov/litigation/admin/2016/34-79003.pdf