Wouldn’t it be great if you could get help with your most irksome compliance or regulatory chore from say, Arthur Levitt, who was the longest serving chairman of the SEC, or Frank Zarb, who served as chairman and CEO of NASD and the Nasdaq Stock Market? Well, your wish has been granted. Last month, both Levitt and Zarb joined Promontory Financial Group (www.promontory.com), a Washington, D.C.-based regulatory compliance and crisis management consulting firm that was launched in 2001 by former U.S. Comptroller of the Currency Eugene Ludwig. Levitt and Zarb came aboard to head up Promontory’s securities practice along with Kathleen Hamm, a managing director at Promontory who spent 10 years in the SEC’s enforcement division. “It’s not often that you get the potential for the coming together of the dream team,” enthused Ludwig in a recent telephone interview. “I can’t imagine a securities area where you could get people that are more knowledgeable than Arthur Levitt and Frank Zarb.” I chatted recently with all four of these heavy hitters–Ludwig, Levitt, Zarb, and Hamm–about their plans to formulate the securities practice, the current regulatory and compliance environment, and what advisors can expect from regulators going forward.
IA: Mr. Ludwig, what prompted you to add the expertise of Mr. Levitt and Mr. Zarb to help formulate the securities practice now?
Ludwig: Securities companies and every company are more than ever pressed to conform to new securities rules, higher standards in terms of controls, and who knows it better than Arthur and Frank? We’re lucky to have the dream team at a time in which we believe we can help a great deal, and the approach we take–which is the high integrity, highly sophisticated group of people doing top-notch work–will resonate with the industry.
IA: What will Promontory’s priorities be as you build out the securities practice?
Hamm: First and foremost, we have the expertise to do internal fact-finding investigations that are important for clients that are under regulatory review or scrutiny. In addition, the second part of building out the practice, in the area that we believe has a tremendous opportunity for growth, is compliance and regulatory reviews for regulated entities and public companies. We have the team, including lawyers, that have securities expertise, business experts, and people like Arthur and Frank who’ve run large Wall Street firms to oversee these types of compliance and regulatory reviews. I think they are important areas for regulated entities, including newly registered [hedge fund] advisors.
Levitt: Frank and I both have the experience of being in the trenches and running a brokerage firm, and then the regulatory experience of running two stock exchanges. It’s our expectation and hope that financial services firms that are facing a dramatically changed regulatory environment–that’s dynamic, not static–would require the objectivity we could bring to an advisory and consulting relationship.
IA: Has the SEC and NASD gone too far in their regulatory scrutiny?
Levitt: Every commission has different priorities than its predecessor commission. It’s not a question of whether one commission is more aggressive than another, it’s that their emphasis may be different. One commission may emphasize investment management and the other might be market structure.
IA: Surely whether the SEC and NASD ease up on issuing regulations plays into how you formulate the securities practice.
Levitt: Because of my tenure at the SEC, I lived through a whole host of issues, and because of Frank’s tenure in the brokerage industry, at the NASD, and in Washington, he’s lived through the waxing and waning of regulatory attitudes. I think we’re able to respond better than most to the significant changes that will be taking place from a regulatory point of view.
Zarb: The environment is one–and this has been going on for a year or two–where the democratized marketplace is moving toward a higher standard of operation, which is complicated by new products and methods of moving those products. The industry needs to anticipate and prepare for those standards, rather than wait for a problem to occur. A key role of Promontory going forward is helping the industry look at these things as they unfold.
IA: Characterize the help Promontory is giving to hedge fund advisors.
Ludwig: In some cases we have been helping them rebuild and enhance their control infrastructure–compliance and risk management to internal audits and governance approaches. We have also done investigations in the securities area that, where the supervisor has asked the entity to have a separate investigation, we’ve done that investigation.
Hamm: For hedge fund advisors recently registered [with the SEC], we’ve offered to do a top to bottom compliance review to make sure they have the systems and the written policies and procedures in place. We have assisted some of those advisors for hedge funds in preparing for examinations and worked with them while the SEC exam staff is looking at their operations.
IA: Has Promontory noticed any new problem areas that advisors are running into in terms of compliance?
Levitt: There has been an explosion of new and very complex products, many of them morphing over into the retail area, which start out as institutionally oriented products–the whole use of derivatives, the fragmenting of the investment into both hedge funds and private equity funds from the original institutional constituents to a more retail constituent by using brokerage firms to make up large blocks allocated to hedge funds or private equity funds. This gets to the issue of suitability. I think that hedge funds have got to be equated with the risks inherent in suitability considerations.
Hamm: We’ve seen newly registered advisors who have bought off-the-shelf compliance manuals or compliance systems and haven’t tailored those compliance manuals or systems to their business.
IA: Some dually-registered advisors are having problems figuring out how to comply with the Merrill Lynch rule. Do you think the SEC will modify the rule?
Levitt: That [rule] is playing out in the courts right now, and clearly the pressure from advisors is greater than it’s been at any time that I can recall. I think the issue that’s raised there is what is the precise definition of what a broker does? Once again, that’s an area where Promontory can be very helpful because it’s essential that if this distinction [between broker and advisor] is going to be preserved, and I’m not sure that it is, but in the meantime, that managements of brokerage firms are aware of, and are familiar with, systems that assure them that brokers are simply executing orders and not giving advice. In an electronic environment, that’s a very difficult task for management to undertake without very sophisticated training and follow-up mechanisms to see to it that they don’t run afoul of what could well be a violation of the law.
IA: Any other areas of expertise that large investment advisory firms would be interested in knowing that Promontory can help them with?
Hamm: Anti-money laundering is an area where Promontory is known globally for our abilities, proficiencies, and expertise. There are pending rules regarding how an investment advisor needs to conduct due diligence and enhance due diligence of clients, and most people anticipate those rules will be final this year.
We also, especially in the RIA space, are able to, and have assisted clients with, making sure they have effective policies and procedures around their soft dollar programs, and around the receipt of business gifts and entertainment, which raise some very complicated issues for broker/dealers but also for RIAs.
Levitt: I also think in terms of trading activity and best execution–market structure issues–[those] are ones that fall under [Promontory's] consulting [expertise].
IA: Looking ahead, what should advisors expect from regulators?
Hamm: In connection with the work we’re doing for a registered investment advisor client, we know that the regulators are focused in on the valuation methodologies that the investment advisors use to value their portfolios.
Washington Bureau Chief Melanie Waddell can be reached at email@example.com.