Compliance - it's a word that elicits an array of responses from mutual fund managers and ETF providers alike, and very few of them are good. But that general uneasiness should not only be attributed to the greater regulatory scrutiny that has become the norm in the post-crisis/Dodd-Frank era. It also comes from the uncertainty about ever-changing regulations, the effort it takes to build the best compliance program and the impact it will have on a fund's operational processes and costs.
Some mutual fund / ETF firms have taken a check-box approach, buying an off-the-shelf program that may or may not fit their needs. Others adhere to the "it's not going to happen to me" model, underestimating the importance and under allocating compliance resources. Many firms have taken their compliance responsibility seriously and have practices in place to ensure what they perceive to be a peak level of compliance. However, these processes, as costly as they may be, can still be ineffective or inefficient. Compliance is not a one-size-fits-all proposition and mutual fund / ETF firms have to build programs that balance cost and effectiveness while matching their evolving business needs. The SEC is casting a wider net, eliminating wiggle room and increasing resources to ensure a greater level of oversight and enforcement. With that increased scrutiny come new levels of anxiety and uncertainty for managers. To ease that anxiety and level the compliance playing field, below are a set of critical considerations to help managers balance their risk and resources in the new era of heightened focus.
1. Know you're in the Regulatory Crosshairs: Topping the 2014 examination priorities list is an initiative targeting never-before examined investment advisers, specifically those registered with the SEC for more than three years with over $100 million in assets. If your firm meets that criteria and hasn't been examined, expect that it will be in the near future. The SEC is adding additional staff to conduct more exams, so if you have been examined, that doesn't mean you're off the hook. Everyone is in the compliance crosshairs. Perform a comprehensive program review and take the first step toward getting your compliance house in order.
2. Take a Practical Approach to Compliance: Programs need to align and incorporate compliance practices with business processes; it's the practical approach. In addition, managers will need to demonstrate how the program is used, tested and reported on regularly. In today's environment, taking a check-box approach will likely lead to a lengthy deficiency letter or even enforcement action which risks your reputation with clients, shareholders and the board.
3. Say Goodbye to Leniency: The SEC is cracking down on infractions across the board. Their "broken window" policy means even 'minor' infractions will be cited. What's more, mutual fund / ETF managers can expect to see more enforcement actions taken on the first visit, as opposed to being given a second chance as may have been the case in the past.
4. Match Compliance Resources with your Risk Profile: As we said before, there is no one-size-fit- all approach to compliance. A mutual fund / ETF firm with a long-only strategy is going to have a much different risk profile than a firm that uses derivatives. Managers must build compliance programs that fit their risk profile. Use the risk profile from your assessment to create, or re-evaluate, a compliance program to match. Some compliance veterans have suggested that a range of 5-7% of revenue should go towards meeting your firm's compliance responsibilities.
5. Tap into Industry Compliance Resources: A search of compliance resources should include industry associations such as NSCP and IAA, as well as firms that provide professional services. Associations produce valuable webinars and industry events focused on compliance. Also look for regional CCO panels, investment round tables and networking events with local managers and firms. Some service providers also bring together CCOs from various clients to discuss trends, current issues and experiences. Managers who have undergone an SEC examination can be invaluable resources for best practice sharing. They may even be willing to share an exam request letter for reference. Professional firms frequently publish regulatory and compliance newsletters that may be beneficial. The SEC also provides valuable resources to help firms build better compliance programs.
6. Don't be Afraid to Mock Yourself: SEC registered investment managers and advisors should start preparing for the examination process by conducting mock examinations.
7. Keep Up on Regulatory Changes: The SEC puts out its priorities annually but managers always have to keep their eyes and ears open for changes that may impact them. In fact some managers may even have to look outside the SEC. Case in point, the Commodities Futures Trading Commission exempted mutual funds from their oversight in 2000 but as of 2012 they eliminated that exemption. Making matters more challenging, the CFTC planned to publish guidance to help managers comply but have not yet done so.
Conclusion: Compliance is no longer an industry buzzword, it is a business imperative. The SEC has made that abundantly clear and funds must operate in this new regulatory reality.
Dave Carson is director of client strategies of Ultimus Fund Solutions.
