On January 16, 2014, The Investment Company Institute ("ICI") released an updated framework for Financial Intermediary Controls and Compliance Assessment Engagements ("FICCA")1. The original framework, developed in 2008, provided guidance for investment companies related to their oversight of the financial intermediaries through which they distribute their products; specifically applicable to omnibus relationships. The framework contains seventeen recommended areas of oversight, from management reporting and risk governance, to processing and technology.
The most recent update to the framework contains several noteworthy improvements. Primary changes include:
* Annual review of the seventeen control areas, previously biennial;
* Addition of Blue Sky reporting review;
* Removal of "Financial Viability," due to its inclusion in the intermediary's audited financial statements;
* Indication of whether each focus area should be addressed in a management assertion or in a control report;
* Glossary of terms;
* Mapping template for control reports, indicating which document would be most appropriate for intermediaries to supply in each of the focus areas.
In addition to the modifications listed above, the matrix containing specific audit requests was updated in several areas. Significant updates include the following:
* An expansion of the Privacy Protection focus area that includes formal documentation, approval and management oversight of the intermediary's Information Security Program;
* Exception reporting with respect to recordkeeping obligations;
* Oversight of compensation activity, including 12b-1, CDSC, commissions, redemption fees, etc.;
* Oversight of subservice providers;
*CUSIP level reconciliation for beneficial owner accounts between the sub-accounting system, the brokerage platform and the omnibus position held on the transfer agent system, with timely exception resolution;
* Additional specificity with regard to shareholder statements and tax information in shareholder communications; and
* The use of third-party provider SSAE-16 reports as an alternative information source.
The primary benefit of this consolidated FICCA report, over the original guidance from 2008, is that it suggests greater efficiencies and flexibility for financial intermediaries in satisfying due diligence requests by the mutual funds they represent.
At its core, the information in the FICCA matrix is intended to assist mutual funds in assessing the adequacy of controls related to the services performed by omnibus providers in exchange for fees paid. However, one of the largest benefits from the receipt of such information is directly related to the current sweep exam being conducted by the SEC. The SEC is currently focusing on the following three areas in its industry information request:
* The various distribution channels and intermediaries utilized to sell and service the Funds;
* All direct and indirect payment streams relating to the Funds' sales and servicing; and
* Oversight of the Funds' distribution, sales and servicing arrangements.
After a round of in-person interviews with targeted firms, the SEC is now conducting stage two of the sweep through extensive information requests.
Two specific areas contained within the ICI's FICCA matrix that may be used to help satisfy those SEC focus areas are sub-accounting and fee calculations. This information can be an important tool in providing fund boards with sufficient information to determine what portion of the fees charged by omnibus providers may be paid pursuant to a fund's 12b-1 plan and what portion may be paid by its shareholder servicing (or similar) plan, as described in the SEC's 1998 ICI no-action letter1. Specific information requests contained in the FICCA matrix that relate to the SEC's inquiry include:
Sub-accounting: Controls provide reasonable assurance that amounts billed for shareholder servicing from financial intermediaries have been calculated and applied in accordance with the terms of the agreement between the intermediary and the fund or its affiliate.
Fee Calculations: Controls provide reasonable assurance that: Initial sales charges, contingent deferred sales charges (CDSCs), Rule 12b-1 fees, and redemption fees have been calculated and applied in accordance with mutual fund prospectus and statement of additional information requirements.
While the information suggested within the matrix may be helpful to fund compliance officers and boards of trustees, there is currently no regulatory requirement for omnibus firms to provide such information. As a result, funds often rely on industry data to determine reasonable costs for shareholder service fees based on an avoided fee approach. Such information is currently available for a cost, but should provide a practical basis for determining reasonableness of account servicing fees in the absence of more transparent omnibus data. To date, it appears that only a limited number of omnibus providers have undergone a specific FICCA review, however, many of these firms may already have the relevant data contained across multiple formats. Given the current SEC attention and FINRA's recent comments that it will focus on conflicts of interest related to intermediary arrangements, the industry is likely to receive additional guidance, either formally, or through related follow-up regulatory action.
Steven Price is Vice President and Deputy Chief Compliance Officer of ALPS.