The industry is still determining what "best practice" is in terms of due diligence and oversight - and it's not there yet.
What is the role of technology for both large and small firms and how should providers evolve to achieve a higher standard of due diligence and oversight?
With more than 20 years of experience in the areas of audit, risk management and compliance, Danielle Sieverling, CCO of the National Rural Electric Cooperative Association, which represents the national interests of cooperative electric utilities, answers these questions and more.
Q: For mutual fund and ETF providers, understanding key risk areas in the valuation process is critical. As the need for transparent, accurate and timely valuation increases in importance, what will be the top areas of focus in compliance for fund managers?
I suspect valuation and intermediary oversight will be at the top of the list for some time. Valuation will always be a significant risk area as you have the potential conflict of interest of inflating valuation to increase assets under management, which in turn results in more money flowing to the investment advisors for the investment management fee. On the shareholder side, there is Rule 22c-1 which requires forward pricing in addition to ensuring that shareholders are buying-in and selling-out at an accurate net asset value (NAV). Lastly, you have to ensure the accuracy of your financial statements and accompanying notes to the financials, including the ASC 820 table.
Over the past few years, we have spent a lot of time talking to our independent pricing vendors - understanding their methodologies, leveraging their transparency tools and establishing new procedures to support the changing regulatory environment. On the intermediary side, I think the industry is still determining what is "best practice" in terms of due diligence and oversight. The ICI, just this year, updated their document titled "Financial Intermediary Controls and Compliance Assessment Engagements" (FICCA). One of the goals with FICCA is to establish a standard for financial intermediaries to report on the effectiveness of their control environment. I have heard that some of the larger brokers-dealers are engaging accounting firms to perform the FICCA but it's too early to tell what the adoption rate will be. In the meantime, firms are using a combination of tools - conference calls, on-site visits, questionnaires and certifications - to monitor their financial intermediary relationships.
Q: What do you see for the future of distribution among mutual fund/ETF managers?
The trend toward intermediary accounts away from the traditional direct sale of fund shares is drastic. Shareholders prefer the convenience of working with a single financial institution, where they have a wide range of investment options. It is likely that this trend will continue so as an industry, we need to establish adequate controls around these growing relationships.
Q: For both large and small fund companies, technology is an intrinsic component of operations. In what ways will technology play a role for providers in the years ahead?
We are a smaller firm so we are always looking at ways to gain efficiency and technology can play a key role in that evaluation. We recently automated all aspects of our code of ethics - pre-clearance, certification, and reporting. It has been a huge time saver for us and most importantly allowed resources to be focused on other regulatory analysis that can't be automated. If we can find an expert in the industry to perform a function that we were previously doing manually, it will be considered.
Q: You recently attended the SEC's compliance outreach program. Can you comment on the SEC's approach to cyber security and distribution?
Providers need to understand what monies are paid to intermediaries and what services are received. The payments are easy but it is often difficult to breakdown the fee between shareholder servicing, distribution and other services.
Guidance states that you should calculate the amounts that the funds would have paid to those entities, as a basis for the calculation. The Board also must be engaged in this topic. The Board should examine any fees paid by the fund's investment adviser.
In conducting this analysis, the advisor must make the payments out of its own resources. In conjunction with determining whether the payments were made from their own resources, the Board should consider whether the profits are legitimate or not excessive.
If the Board is satisfied with this analysis, then a conclusion can be drawn that the payments are made out of the advisers own resources.
Cyber security was also a topic of the SEC's compliance outreach program. In listening to the discussion, the SEC encouraged registrants to self-report any instances of securities breaches to the SEC. It was noted that is an expanding risk and one that must be taken seriously.
To that end, firm policies and procedures should specifically address cyber security. The SEC is holding a cyber security roundtable on March 26, which is open to the public and will be available on live webcast. The SEC is interested in understanding how market participants manage cyber security threats.
