The high price of not keeping up with regulatory demands is well documented, but some in the fund industry are growing increasingly concerned about the growing costs of implementing new measures to keep up with a steady stream of proposed requirements.
The Securities and Exchange Commission, as well as other regulatory and trade groups, such as the Investment Company Institute, have in recent months proposed increased disclosure of costs at the point of sale, as well as of breakpoints.
Critics of the proposed rules say the costs could be prohibitive, especially for smaller firms. However, like it or not, increased regulation is coming, and firms are trying to find the right blend of IT and compliance solutions without burning a lot of dough.
"Proposed SEC rules and those adopted in recent months will impose substantial IT and compliance burdens, and these are measured in millions of hours and hundreds of millions of dollars, if not more," said Steven Stone, a partner in the securities and investment management practice at Morgan, Lewis & Bockius, speaking at a recent Securities Industry News Web seminar titled "Bridging the Gap Between IT and Compliance." SIN is a Thomson Media publication and sister publication to MME.
Stone said the SEC proposal for point-of-sale disclosure of revenue-sharing agreements and related issues will cost the industry 18.7 million hours and $100 million in outside vending. The trick is to successfully bring together IT and compliance efforts to bring about cost-effective compliance solutions, Stone said.
The Securities Industry Association is planning to come out with a letter identifying and opposing many aspects of the fund disclosure rules, according to Mary Jane Delaney, senior vice president and director of compliance and private client group counsel at RBC Dain Rauscher. The SIA said the letter will be put out this month, but gave no date as to its release. Delaney said the SEC likely significantly underestimated the IT costs of implementing just this one rule by "hundreds of millions, if not tens of millions." And that is just one proposal, with others surely to come down the pike in the future, she said.
"The regulators continue to propose new rule changes that are quite demanding," said John Gerbauer, executive vice president and chief information officer of compliance consulting firm National Regulatory Services. NRS is part of Thomson Financial, sister company to Thomson Media, publisher of this newsletter.
Gerbauer said many of NRS' clients, both large and small, are struggling with finding the correct balance. Fidelity Investments and American Express Financial are among some of NRS' 6,000 clients. Many of the issues require major efforts between firms' compliance and IT departments, he said, citing the new mutual fund-related disclosure issues regarding linking of accounts and breakpoints.
The stakes are certainly higher these days. The NASD brought more than 80 enforcement actions in 2003 and so far this year for violations concerning the sale of mutual funds and pooled investment products, said Mary L. Shapiro, NASD vice chairman and president of regulatory policy and oversight, during recent testimony before the Senate Committee on Banking, Housing and Urban Affairs. Additionally, the NASD has brought 15 cases involving missed breakpoint discounts on shares with front-end load sales charges, she testified.
In a settlement with the SEC last year, Morgan Stanley agreed to pay $50 million in disgorgement and penalties in relation to its failure to disclose, at the point of sale, the higher costs associated with B shares as well as neglecting to inform customers of its "Partners Program," which provided incentives for its brokers and the firm overall to recommend some funds over others.
Also, in February, regulators announced that 15 firms agreed to pay more than $21.5 million in penalties, and repay investors an estimated $86 million, for not giving breakpoint discounts.
And just last week, the SEC announced a settlement with Massachusetts Financial Services, resulting in a $50 million fine for the firm for failing to disclose directed-brokerage agreements. (see At Deadline).
"We're facing unprecedented times when IT and compliance have to work together more closely than ever," Delaney said. "Certainly, shops should consider whether or not IT should be embedded in compliance."
In the last 10 years, IT has been isolated from legal and compliance in a number of shops and viewed as a back-office operation segmented from the middle office of legal and compliance, according to Stone. But "now, increasingly, IT is looked to as a key solution to many compliance issues in the minds of legal and compliance professionals, and this is reflected in the significant rise over the past couple of years in IT spending in the securities industries."
Coping with the increased demands takes some creativity and integration of different types of jobs. Delaney said her firm has created a group in the compliance department that is an IT group, which possesses expertise both in IT and compliance. "We have actually created a data warehouse, which is conceived of, and crafted by, the compliance professionals and then handed over to IT to actually put the bells and whistles on it for use."
This has become extremely important to the firm, she said. As a result, RBC was able to go back and look at the timeframe in which breakpoints could have been missed and determine any customers who were not given the appropriate discounts.
"Rather than create an expensive and full-time [department devoted to] claims, we simply paid clients back and sent them claim forms with their check in case they questioned our calculation," she said. "We would not have been able to do that without having built this extraordinarily comprehensive warehouse. And we couldn't have accomplished it without the help of the IT folks."
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