An investment bank was fined and censured for failing to enforce information barriers between its research department and an affiliated hedge fund managed by the bank’s CEO. The investment bank maintained policies and procedures related to the misuse of material nonpublic information, including a restricted list applicable to the bank’s employees. However, the restricted list did not stop the hedge fund from making 126 trades in restricted list securities over a 6-month period. In response to deficiencies raised during an SEC examination that occurred before the unlawful trading, the hedge fund adopted policies and procedures that applied the restricted list, required physical barriers, instituted email monitoring, and restricted information flow. The SEC alleges that the hedge fund failed to enforce those policies.
OUR TAKE: Compliance means more than a drafting unused policies and procedures. It means actually enforcing those policies to prevent unlawful conduct. This firm likely incurred the enforcement action because it told the SEC that it had fixed the problem by adopting policies and procedures but then ignored implementation.
A KPMG study reports that the overwhelming majority (94%) of hedge fund managers recognize the importance of investing in technology to compete and that compliance is a top reason (90%) to invest in technology. The report explains: “Given that — in 2013 — we estimated that compliance was costing the industry upwards of US$3 billion per year (and that number has likely risen much higher since), it is not surprising that compliance ranked as a top objective among our respondents.” The report also explains the importance of technology in the back office where improved data management allows firms “to meet the increased regulatory and investor reporting demands being placed on them.”
OUR TAKE: Technology that organizes and presents data has become a critical element to meet ever-increasing regulatory requirements especially in areas such as personal trading, email review, and investor reporting. Technology alone, however, is not a regulatory silver bullet. Firms must still retain top compliance talent who can assess, interpret, and react to the data and then advise senior management on how to proceed.
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.