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December 23, 2013

How to Establish a Culture of Compliance

Passing an examination isn’t all about documents and disclosures

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  • The Custody Rule and its Ramifications When an RIA takes custody of a client’s funds or securities, risk to that individual increases dramatically. Rule 206(4)-2 under the Investment Advisers Act (better known as the Custody Rule), was passed to protect clients from unscrupulous investors.
  • Books and Records Rule Thorough and complete books and records enable RIAs to demonstrate that they have fulfilled their fiduciary obligations to clients and complied with applicable rules and regulations.

Well, another month has passed, and this administration still loathes the financial services industry. On a positive note, at 55 years old, I now have pre- and post-natal care covered by my medical insurance policy—ah, progress. Thank you, Washington.

Last month, I warned the advisory community that the SEC is coming. I discussed SEC Chairwoman Mary Jo White’s “felt and feared” and “Giuliani-style approach” comments. I respectfully submit that those comments, as they relate to the advisory community, were when made—and continue to be—misplaced. Nevertheless, this is the SEC’s position, and all SEC-registered advisors must take notice. Advisors who have never been examined should take particular notice given comments by Andrew Bowden, director of the SEC Office of Compliance Inspections and Examinations, that all such advisors can expect to be examined in 2014. In addition to never-before-examined advisors, advisors to private investment funds will also face an aggressive examination schedule.

The aggressive enforcement posture announced by White may not be unanimously shared by all commissioners, but it will dominate the regulatory landscape in the foreseeable future. Given the landscape and recent SEC pronouncements, what should advisors do now from a macro perspective to demonstrate the appropriate culture of compliance from the top down?

First, in an address to the National Society of Compliance Professionals, White indicated: “We want your firms to know, at every level, how important your work is to investors and to us. And we will be looking for more cases to bring to drive that message home.” Thus, does your firm have the right chief compliance officer? Has he or she been empowered by senior management to discharge his or her compliance-related duties? Does the CCO have a thorough understanding of those duties? These are very important issues for the SEC during an exam, and rightfully so. Remember, the commission will want to meet with the CCO as the point person during the examination process, and it will be able to discern quite quickly whether or not the CCO is competent and has been given the resources and authority to discharge his or her duties.

In addition, I strongly recommend that the CCO’s role be looked upon as that of a firm management position. If the firm has non-compliance-related committees (e.g., investment), the CCO should attend those meetings so that he or she has a broad understanding of the firm’s operations and can share any corresponding compliance-related issues that may arise. If compliance shortcomings during an examination (including those of the CCO) can be attributed to the lack of importance, authority, resources or standing within the firm, senior management beware—you will have some explaining to do.

Also, if the “tone at the top” is lacking, address it immediately. If the current CCO is not the right person for the job, replace him or her. If he or she is, but lacks the authority and resources, remedy it. Do not wait for regulators to address it.

Without the appropriate importance and resources given to compliance and the individuals responsible for such functions, a firm’s compliance efforts are doomed to fail. Please be guided accordingly.

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