Cindy Fornelli is walking the walk.

The former deputy director of the SEC's division of investment management who helped engineer a bulk of the new regulations governing mutual funds now has skin in the game, as she toils in the compliance trenches of a company rocked by the mutual fund trading scandal.

Bank of America, which oversees the Nations and Columbia fund families, recently ponied up $675 million to close the books on allegations of improper trading that sparked an industrywide probe a year and a half ago, resulting in the largest mutual fund settlement to date.

Now, with a number of senior executives and board members ousted and a former BoA broker facing felony fraud charges, the nation's second-largest bank is looking to send a message that it has cleaned up its act. One of the ways the Charlotte, N.C. -based firm is righting the ship is by hiring former regulators to oversee its compliance functions.

Enter Fornelli, a Kansas City, Mo. native who joined BoA last August after a six-year stint as a policymaker for the SEC and more than a decade building compliance programs for investment advisors. An expert on mutual funds and compliance, Fornelli, in the newly created position of Compliance Executive for Securities Regulation and Conflicts Management, is responsible for looking around corners and over hills for potential conflicts that could arise across the bank's different lines of business.

Affectionately called the "Conflicts Czar" by her peers, Fornelli faces the daunting task of coping with the fallout from the bank's recent legal entanglements and its blockbuster merger with FleetBoston. Driven by a tireless work ethic and strong Midwestern values, traits imparted by her late father Bill Fornelli, a former steelworker, Fornelli is proving her mettle among the regulated by rolling up her sleeves and putting her policies to the test in the real world.

Money Management Executive Senior Editor Kevin Burke caught up with the affable attorney in her corner office at 100 North Tryon Street overlooking downtown Charlotte, where she is still getting used to the slower pace of the South and its fewer shopping hot spots.

To hear more on her new digs, her proposed fixes for the rift between funds and regulators and where the industry is headed, read on:

MME: What was the impetus behind your departure from the SEC?

Fornelli: It was the right time to go. I know it sounds corny but I firmly believe that you have to eat your own cooking. When I was at the SEC, it was the most active time in recent history, perhaps in the whole history of the division of investment management, where I was an integral part of numerous regulatory reforms. I really had a large role in driving that policy, and I was very curious, "did we get it right?"

I know we certainly did it right theoretically, but did we do it right practically as well? An in-house role in compliance certainly puts you in a very good position to see how it really does work, to see the practical aspects of the laws we created and why we created them.

MME: What does your arrival mean for Bank of America as it looks to avoid future transgressions?

Fornelli: My having come from the division of investment management brings a certain amount of credibility with regulators, and demonstrates that the bank is committed to doing the right thing. That's part of what made me an attractive candidate.

I should point out that the bank was being proactive in that they conceived this position before the mutual fund reforms hit. But I also think that the reform effort crystallized how important such a role is. The bank was looking for a way to be able to speak better to securities regulators, and having come from the SEC, I certainly am in a position to do that. So one of the ways the bank is doing the right thing is it is bringing in former regulators.

MME: Has your recent experience among the regulated yielded any new perspectives?

Fornelli: I've learned that one size doesn't fit all.

While the bank has always tried to take an enterprise perspective, up until now there hasn't been a program or unit focused on that. While each line of business has compliance professionals working with it to develop, implement and monitor that line of business, my role is to look across the bank horizontally to bring all the pieces together.

This is a fascinating but challenging position because I really get to see how all the pieces fit. I've also learned that I have to be flexible to make things work for each line of business and take into account their specific needs.

Regulators have to do that too - look across the vast, diverse fund industry as a whole and develop regulations that are flexible enough to be tailored to each unique mutual fund. At the Commission, we spent a good deal of time trying to do that. Being in-house really highlights how critical that is and how difficult that can be.

MME: How would you characterize the state of the fund industry in the aftermath of the scandal?

Fornelli: Regulators, Congress and the press all have had their flashlights shining on the fund industry. While it's been difficult, it's resulted in some good reforms.

Mutual funds are a mature industry and perhaps all parties involved got a little complacent.

When I first joined the SEC, mutual funds were considered a sleepy backwater and investment management was the "quiet division." I don't want to say that the industry got away from us, but perhaps regulators, the industry - all parties involved - might not have been as focused on the innovation and growth in the industry as we should have been.

It's been a wake-up call, and everybody has rallied around it. The industry needed to be modernized and reformed, and the difficulties of the past couple of years were certainly a driver in making sure that happened, although it would have been healthier had there been a better prompt. Still, you saw investors stay in mutual funds because they are, fundamentally, a good investment.

MME: There seems to have developed a rift between the SEC and the fund industry in recent years. What is the root cause of that disconnect?

Fornelli: The SEC and the fund industry have gone through some growing pains. There's been a slew of new rules that funds have to comply with and understand. They have come fast on the heels of one another, and I think the industry feels as though it needs some time to catch its breath.

Rightfully so, a lot of the new rules have given fund complexes the flexibility they need to tailor their programs. But any time you have that flexibility, it's going to take a while for firms to get those programs up and running and get them right.

There is a perception that perhaps the SEC staff isn't going to give the industry the time that it needs to get those programs right, generating a lot of nervousness and apprehension.

These are uncharted waters and the industry is looking for guidance from the SEC as to what its expectations are. You have to contrast that with the fear that the guidance will come in the form of a deficiency letter or an enforcement action.

MME: What will it take to bring both sides together?

Fornelli: The industry and the SEC need to look for forums where the SEC staff can talk about what its expectations are, what the responsibilities of the funds are, and at the same time, where fund firms can say where they're experiencing some difficulty.

I've advocated holding public educational forums, workshops or roundtables a certain period of time after a rule has gone into effect, be it 12 months or 18 months later. These would be opportunities for the industry to meet with staff to share what difficulties funds are having complying with certain aspects of a rule or share any of its unintended consequences.

I've also suggested publicly having a staff member from the operating or policy divisions accompany examinations staff on exams. This would benefit everyone. The investment management staff attorney who goes along on the exam would see firsthand how a particular rule actually works at a fund complex. The examination staffer would have an opportunity to better understand the policy behind the rule. The fund being examined also would benefit because it would provide another way for the industry to interact with both policy makers and examination staff. Ultimately, there needs to be a collaborative effort, one that brings SEC staff together in a cohesive, unified approach.

MME: The new compliance rule has left many CCOs scratching their heads. Will the SEC's CCO Outreach program ensure a smooth transition?

Fornelli: The CCO provision is rather complex, so the transition period will be difficult.

It is important that there be a dialogue between the industry and the SEC staff. Sometimes it's hard for mutual funds to reach out to a regulator and say, "We need help with this rule." There's a natural hesitancy on the industry's part. On the other hand, the industry keeps saying that it wants the ability to reach out to regulators, so the SEC has created the opportunity, and the industry should give the SEC the benefit of the doubt and really try to make it work.

For the outreach program to be effective, the SEC is going to have to give funds some room and lend guidance when the industry is legitimately struggling with an issue. This should be done in a public way, so that the SEC can preserve its resources by not having to answer the same question over and over.

MME: Many firms are struggling with determining compensation for CCOs. What are the potential conflicts and how they are being addressed?

Fornelli: Certainly, if part of a CCO's compensation is based on the profitability of the firm, the firm's going to want to make sure it is very transparent and that the board is closely involved in the decision.

At the end of the day, it's really the board that has to approve CCO compensation. But if you have part of that compensation tied to the profits of the firm, the potential conflict there is you may be setting up the CCO not to report problems that he or she sees. That being said, a lot of firms have found it easier to pay the CCO a straight salary.

MME: What about overseeing third-party service providers?

Fornelli: Some firms rely on certification. Some rely on scheduled visits, surprise visits or at least annual visits to the service provider.

Whatever the mutual fund complexes ultimately decide, it's important that the CCO be actively engaged in understanding what the service provider's compliance programs consist of, how they're implemented, if there are changes and certainly if there are problems.

There has to be a constant dialogue between the CCO and the service provider. It's not something that you can just check off a list once a year. Just calling them up and saying, "Hey, are you guys okay?" and the service provider saying "yeah," is not enough for the CCO to be able to demonstrate compliance.

MME: Many of the market timing and late trading cases revealed abuse at the omnibus account level. How does a CCO drill down far enough to prevent abuse?

Fornelli: The SEC adopted a redemption fee rule that provides guidance on the omnibus issue.

The rule, which funds and their intermediaries must be in compliance with no later than Oct. 16, 2006, requires funds and their intermediaries to enter into written agreements that ensure intermediaries will provide funds with certain information regarding fund shareholders so that funds can monitor for market timing and ensure that their instructions are carried out.

The SEC's rule provides funds with flexibility so that they can receive the information periodically or upon request.

The rule notes that this is an important tool for fund CCOs in carrying out their obligations to monitor for market timing. In my view, the CCO would want to be involved in negotiating this agreement and have input as to what information will be passed through and how often.

MME: How should CCOs report violations to the board and what kind of relationship should they have?

Fornelli: One would hope that the CCO and the board will develop a close working relationship and that they will be in frequent contact to ensure ample opportunity for a CCO to raise concerns, regardless of whether there is formal violation or not. While the rule requires the CCO to make a formal presentation to the board on an annual basis, and while the SEC staff has indicated that perhaps quarterly meetings would be good practice, I would hope that over time the CCO and the board (or perhaps a particular board member or two) would develop a more informal relationship that would allow for much more frequent communication.

MME: What is your take on outsourcing the compliance function?

Fornelli: If you're going to farm out some of the functions, the CCO needs to be on top of what those functions are and also be very, very cognizant of the fact that you can't farm out responsibility under any circumstances. That's probably something the SEC would be very concerned about in that scenario.

MME: Does a CCO wearing different hats within a fund complex create conflict?

Fornelli: There are some hats that can create more conflicts than others, and so a CCO would want to be careful of that and make sure that he or she isn't wearing too many hats. A CCO serving as the head of marketing, for example is not the best two hats to be wearing. Obviously, that would be problematic.

One thing you have to be wary of is making sure you're wearing the right hat if you're trying to cloak something under privilege. Just because a CCO is also general counsel doesn't mean that everything is going to be protected under privilege.

MME: How do you see the new compliance rules shaking out?

Fornelli: What's important is that we seize this opportunity to take a step back, reassess, and put into place compliance programs that really get to the heart of the matter, not just a routine, check-the-box function.

It could really be meaningful as the SEC envisioned, with the CCO and compliance rules delivering compliance programs that are tailor-made to align shareholders and the goals of the mutual fund, which, at the end of the day, is commerce. If fund complexes really work to get it right, and the SEC gives them the freedom to get it right, it'll work brilliantly.

If, however, it just becomes one more item on a laundry list of things to do, then it won't be meaningful. We're right at that crossroads, and the next six to 12 months will be critical for the industry.

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