A decade ago, the fund industry got mired in a market-timing scandal, involving the placement of orders after the market closed.
Making it easy to hide trades that came in after the close was the omnibus account. These are accounts that a brokerage uses to bundle together customers' orders. If a brokerage had an hour or two to send the net buy or net sell order on to a fund, it wasn't that hard to slip in late trades, without the fund being aware that anything had happened.
Speed forward to the present and there are questions about whether investors are getting the discounts on sales charges they are entitled to when their investment in a fund reaches a given "break point." And whether abusive short-term trading also is being hidden inside omnibus accounts, into which funds have little visibility.
Thus the arrival at the end of September of a white paper from NICSA, the National Investment Company Service Association, on how to effectively oversee broker-dealers, fund supermarkets, online platforms, registered investment advisers and other "intermediaries" who manage relationship with a fund's shareholders.
Today, NICSA says 80 or 90% of a given fund family's assets can be held in omnibus accounts.
"It's been a sea change for fund transfer agents,'' said president Theresa Hamacher.
Fund transfer agents typically maintain financial records and account information on fund shareholders and handle such tasks as the disbursement of dividends or the mailing of trade confirmations.
The "sea change,'' which Hamacher said accelerated in the past 18 months, means omnibus accounts have largely supplanted what are called networking accounts.
With the networking approach set up by the Depository Trust and Clearing Corporation in 1988, fund transfer agents and intermediaries each kept individual accounts for investors on their own systems. Then, they used the DTCC system to tell each other about share transfers, dividend payments and other account activity.
The individual account information could be rolled up into consolidated account statements, by the intermediaries. But the funds still could see what was happening in the individual accounts.
With omnibus accounts, the intermediary maintains all the individual investor accounts, allowing them to better serve their customers. All the fund sees is the aggregate holdings of a single account at the broker, the omnibus account.
That means the intermediary has to enforce the rules in a mutual fund prospectus. The fund has little ability to see if the rules are in fact being enforced or regulations followed.
That led the Investment Company Institute in 2008 to coordinate an industry effort to find a way to limit the risks of hidden or misunderstood activity that can be enabled by omnibus accounting.
That in turn led to the creation of an attestation report that brokers and other intermediaries would deliver to fund sponsors, affirming that the accounts were being handled properly, rules followed and customers getting, for instance, the fee breaks to which they might be entitled.
"Essentially, the transfer agent needs to have an assurance that an omnibus record-keeping is complying with all the fund rules,'' said Hamacher.
That Financial Intermediary Controls & Compliance Assessment is not just a report that intermediaries fill out and sponsors file away.
A dozen areas in the assessment are considered "testable" and subject to an auditor's report, prepared by the standards of the American Institute of Certified Public Accountants.
These control areas include setup and maintenance of the account for the ultimate "beneficial" owner, shareholder communications, fee calculations, adoption of appropriate information technology, cash and share reconciliations, the prompt and proper identification of abandoned accounts, billing and invoice processing, document retention and record-keeping and even codes of ethics.
It's a voluntary assessment. So far, only two broker-dealers have had auditors conduct the assessments and provide the report to transfer agents, NICSA said. But several firms have started to engage an independent auditor or accounting firm to conduct a FICC assessment.
Fund transfer agents now have to define expectations and verify performance of brokers and other intermediaries.
"It takes some energy to do,'' Hamacher said.
BEST PRACTICES: Governing Intermediaries
The shift toward omnibus accounts by broker-dealers has required that fund transfer agents develop enhanced approaches toward monitoring shareholder recordkeeping and ensuring that funds, service providers, and intermediaries remain in compliance with all prospectus rules and applicable regulations.
Here are five steps to take, as recommended by the NICSA Intermediary Discussion Forum, in September 2012.
1. Establish a working group
Staff handling governance issues often are scattered through multiple departments at a fund firm. Consolidate these into a single working group and make sure the appropriate technology and operations skills are included.
2. Establish an oversight committee
Transfer agents should establish a committee for overseeing intermediary governance, identifying risks and resolving them. This committee should include senior executives in addition to members of the working group. With senior executive representation, this committee should be able to respond quickly to concerns that may develop.
3. Create scorecards
If you can't measure it, you can't manage it. Develop a "risk matrix" or scorecard that identifies problem areas, prioritizes areas of concern and uses some form of metrics to assess risk and manage the resolution. A scorecard should be maintained for each intermediary that uses omnibus accounting.
4. Communicate often with fund boards
Because 80 or 90 percent of assets can be held in omnibus accounts, governance of intermediaries is critical to fund boards of directors. Fund transfer agents should communicate often with boards about their approach and results.
5. Use the FICCA framework
A Financial Intermediary Controls and Compliance Assessment is prepared by an independent accounting firm retained by the omnibus intermediary or record-keeper. The accounting firm will assess the intermediary's controls in 17 areas and report back to fund transfer agents.
Using the standardized tool should reduce costs for intermediaries, by reducing the number of information requests from fund managers and making reporting manageable.
SOURCE: "Effective Intermediary Governance," NICSA