More On Legal & Compliancefrom The Advisor's Professional Library
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
On the face of it, the idea of marrying operations and compliance seems natural. But such a marriage is not about combining two separate functions into one. Rather, it is about integrating and leveraging for the compliance function.
The roles of compliance and operations are built on different models and serve different and equally important purposes, with many firms taking a silo approach to the two functions, however, the two roles are inextricably linked.
In the SEC's November 14 CCO Outreach Seminar for Chief Compliance Officers of RIAs, one of the leading topics was "Compliance and Operations--The Importance of Synergy." Regulators are looking to compliance officers to become more innovative in their approach through the integration of compliance and operations. Through integration, a compliance team's ability to operate more proactively to detect, prevent, and respond to potential securities violations is significantly enhanced. With regulators looking to compliance officers to proactively detect and prevent wrongdoing, compliance must move beyond its traditional advisory role and synergize with operations.
Today's complex investment management industry brings compliance officers face to face with a myriad of regulations, quickly changing markets, the growing use of technology, and the difficult task of addressing all the required regulatory requirements. The point was driven home by Lori Richards director of the SEC's Office of Compliance Inspections and Examinations in a speech at the National Society of Compliance Professionals 2007 Membership Meeting. Richard noted that, "In the past, I've thought that the operational aspects of compliance didn't receive the attention they deserved, and that too much focus was placed on discrete legal requirements--too much on the end result and not enough on the how-to."
Richards continued that, "compliance plays an operational role and has a toolkit that is different from that used by lawyers in a firm's legal department." In this increasingly complex environment, then, to effectively detect and prevent violations from occurring, compliance officers need to have a compliance program that works on a real-time basis and leverages other business functions for compliance efforts.
In order to succeed as a business grows, compliance officers must remain abreast of the operational developments affecting their firm, leverage operations functions to complete compliance tasks, and fully exploit the synergies that exist between compliance and operations.
One of the primary areas where synergies can be maximized is in trading. Accurate, efficient transaction processing and reconciliations are key operations goals. Compliance's goals include best execution, trade error detection, fair and equitable trade aggregation and allocation, and adherence to client guideliness.
For example, the compliance function of monitoring and evaluating trade aggregation and allocation can occur during the operations function of trade reconciliation. Operations personnel are also in a unique position to review for trade errors and to provide data for the compliance function of evaluating best execution.
Another example where firms can utilize operations for compliance functions is in the monitoring of client guidelines and restrictions. Many firms implement "hard" and "soft" pre-trade restrictions in their order management systems to ensure compliance with client investment guidelines and restrictions. Again, the compliance role can leverage operations because operations is in the best position to evaluate compliance with these restrictions. The trading process can be very complicated, with many variations depending on the nature of the firm's investment objectives and policies, but by integrating various operations functions with compliance functions, firms are in a position to develop a robust compliance program.
Adding Risk to the Equation
The development of a compliance program in a fast-paced, technology driven complex marketplace becomes an increasingly intricate task with the intersection of risk management, compliance, operations, and technology.
Andrew Donohue, director of the SEC's Division of Investment Management, highlighted the complexities of the financial marketplace and the intersection of risk management, compliance, operations, and technology in a speech he gave at the Investment Company Institute's 2007 Operations and Technology Conference. Investment managers aggressively using derivatives is a prime example of this intersection, Donahue said (see "Avoiding Mismatches" sidebar). Among the operations/compliance issues created by derivatives trading are counterparty risk (the risk that one side may default), the creation of leverage in a derivatives transaction (which is prohibited for '40 Act funds), and settlement risk.
With the increasing complexities and demands on an institution's compliance function, it is an additional challenge to ensure compliance does not become a burden on the firm's business or growth. However, as firms venture into more complex investment products, those that leverage the operations functions for compliance will be in a superior position for regulatory exams. As in the examples above, by integrating the two functions of compliance and operations, firms are ultimately able to create efficiencies, improve controls and compliance procedures, save on costs, address regulatory demands and strengthen operational procedures.
Salvatore J. Papa, JD, is a VP for IMS Consulting Partners Inc. in New York, a global compliance firm that provides consulting, educational training, and technological solutions for investment managers, broker/dealers and hedge funds. He consults on a wide variety of compliance and regulatory matters affecting investment advisors. Keith J. Marks, JD, is a Partner with IMS Consulting in Connecticut who provides on-site mock examinations and registration services to the investment advisor divisions of regional banks, hedge funds, institutional advisors, wrap fee managers, and Internet-based advisers. They can be reached through www.imsconsulting.us.