The Securities and Exchange Commission has been soft-pedaling its expectations for mutual fund chief compliance officers recently in an effort to alleviate concerns that its new compliance rule would effectively make them a junior police squad for the regulatory agency.
The compliance rule enacted last October requiring mutual funds to appoint a chief compliance officer was aimed at rooting out compliance issues and conflicts of interest before they become a quagmire. The SEC has talked tough about the CCO being on the hook for abusive practices, lax internal controls and potential fraud cases within a fund complex as part of its new regulatory agenda in the wake of the recent market-timing and late-trading scandals.
However, the Commission has not provided a lot of clarity on issues that pertain to CCOs, such as overseeing third-party service providers, for example, something CCOs are struggling to get their arms around. As a result, there is concern in the industry that the SEC will try to narrow the rule through enforcement rather than offering guidance, thus putting CCOs in a precarious position.
"When it first came out a lot of people were very concerned that 38a-1 brought a whole new impetus to the word compliance and that really what we were creating was this internal watchdog agency," said Tom Westle, a partner at New York law firm Blank Rome.
In response to industrywide anxiety over the inherent ambiguity and tension that comes with the position, the SEC has established a "CCO Outreach" program that will get underway sometime in late spring to early summer.
"Fund CCOs are the eyes and ears of the board on matters of compliance. We view CCOs as our allies in our parallel mission to protect investors, so we want to assist CCOs to fulfill their function," said SEC Chairman William Donaldson, delivering a keynote address at the Mutual Funds and Investment Management Conference last week, sponsored by the Investment Company Institute and Federal Bar Association.
Donaldson said that the Commission's examination staff will host regional seminars at which CCOs can learn the "nuts and bolts" of the examination process and what resources will be available to them. The regional seminars will serve as a lead-up to the agency's first CCO National Seminar, to be held at SEC headquarters in early fall, where roughly 500 CCOs will be in attendance.
Donaldson also assured conference attendees that the SEC is not assembling CCOs as an army of whistleblowers. "It is not an effort by the Commission to re-write the fund's reporting structure - fund CCOs continue to report to the fund's board," Donaldson said. "It also is not an effort to deputize' CCOs as agents of the SEC.
Rather, he noted, it is designed to improve communication with CCOs, answer their questions, and give them the information and support they need from the Commission to perform their critical oversight function.
The outreach program was not short on detractors, however, as two attorneys who participated in a conference panel discussion rebuked the Commission's efforts. Marianne Smythe, a partner at Wilmer Cutler Pickering Hale and Dorr known for her unabashed and often snarky remarks, barbed that the SEC's program sounds like "a support group for recidivist fathers."
Another panelist, Kathryn McGrath, called on the Commission to address CCOs' real concerns rather than inviting them to "CCO Camp." Specifically, she cited a footnote in Rule 38a-1 that stipulates if a CCO is relieved of their duties at a particular firm for whatever reason, any company that hires that individual thereafter will face more stringent oversight. Many folks in the industry view the footnote as a land mine that could sabotage a career.
Still, others are more optimistic about the SEC's outreach program. Overall, the industry really looked at it as a very positive gesture by the SEC, to make sure that this is a comprehensive program that would actually work, Westle said. But the industry must proceed with caution because there are potential pitfalls that lay ahead, he added.
"The initial fears may subside a little bit, but it's going to depend on how the SEC deals with it over time," Westle continued. "If you start seeing examinations where the CCO is their first line of offense, then people's fears are going to be justified." Ultimately, he expects it to become another routine part of the business.
Westle, who represents independent directors and mutual funds, noted that CCOs must be granted protections to ensure their effectiveness. "One of the things that has become very obvious is you cannot put the CCO in the position of responding to board inquiries while the people that he otherwise works with are sitting at the same board table," he said. "It's not fair to the CCO, and it's really not going to make them very candid."
Robert Kuruzca, a partner at Morrison & Foerster and a former assistant director of the SEC's division of investment management, expressed concern about the danger of putting a bull's-eye on their backs. "If we make the position so onerous and imposing, in terms of the downside, it's going to be hard to find [candidates] who are willing to serve as CCOs over time."
Lines of Communication
As part of the outreach program, the SEC plans to publish a periodic newsletter called CCO Observer, which will address issues such as implementing new rules, interpretive releases, recent examination findings and relevant enforcement actions. The newsletter will be written in "plain English" and contain electronic links to relevant materials on the SEC Web site. A videoconferencing feature is also being considered.
The SEC also has established an Exam HotLine that CCOs can call to report a complaint or express concerns about a particular examination. Senior attorneys from its examination program's chief counsel office will field the calls. It has yet to be determined whether the callers will be allowed to remain anonymous. The SEC declined to comment further on the framework of the outreach program.