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News June 21, 2004 Issue

IM Insight Talks to . . . David D. Brown, IV, Chief of New York Attorney General Eliot Spitzer’s Investment Protection Bureau

You’ve probably heard a thing or two about his boss. But as lawyers caught up in the fund scandal can attest, David Brown, a former in-house counsel at Goldman Sachs, has been the day-to-day force behind Eliot Spitzer’s fund investigations. In an exclusive interview, IM Insight talked to David about the role of compliance officers, lessons he hopes the industry has learned, and what’s next in the fund investigations.

IMI: Based on what you’ve seen over the past year, what do you think makes for a good compliance officer?

DB: The main thing is to avoid being “captured” by the business line, in the sense of identifying with them to the extent that your judgment is clouded. Part of what all [compliance officers] are really being paid for is to preserve some independence and judgment and to be able to say “No.” It can be difficult as time passes and you work very closely with people in the business line to take positions that are contrary to what they want to do. But that’s what the best compliance officers are able to do.

On a practical level, I think the really good compliance people are people who are not afraid to ask questions that may sound simplistic or dumb within their organizations, so that they are able to truly understand what their business line is telling them. I think you have to have a thick skin and keep asking questions until you thoroughly understand how a business makes its money. Once you understand that, I think you’re there.

A lot of times you have to cut through a lot of jargon and a lot of fast talk by people who are professional talkers and who want nothing more than to snow you and have you go away. You have to have a certain level of maturity and self-confidence to sit there and ask what you may feel are dumb questions. The best compliance people are able to just stick with it, asking those questions until they are able to repeat back in their own words exactly how a business works and they thoroughly understand it. And only then can you monitor it.

There has to be sort’ve a doggedness to understanding why things are done the way they are. There are three answers to the question of “Why do we do it this way?” that a compliance officer should not be satisfied with. One is “We’ve always done it this way”; two is: “Everyone else does it this way”; three is: “We make money doing it this way.” None of those are explanations. If people have a gut-level concern about the propriety of a business line, they should be pushing beyond all of those and making sure that their instincts are being addressed as to why something makes sense.

You can see from various things we’ve been through — including the mutual fund scandal — that there are times when it seems like an industry or a large part of it can kind of lose its way. The mere fact that you’ve always done it that way and everyone else does it that way and that it’s profitable will be no defense whatsoever.

It’s also helpful to keep track of the various scandals that have happened over the last few years, maybe going back into the 80’s. All of these really negative possible outcomes are tools that you can use. When you feel that you are on the losing side of a conversation with a business person who is saying “This is the way we’ve always done it, this is the way everyone does it,” you can say “This reminds me of [this or that scandal].” These regulatory and criminal penalties are a tool, in that they will make even the most aggressive business people stop and think. It’s probably helpful to be able to cite some of them and be able to — in a realistic way — point out how something, if taken the wrong way, could lead to a really serious result. There are lots and lots of examples out there now, and a well-chosen analogy could probably help people a lot.

It’s a constant internal back and forth. Hopefully it’s collaborative and everyone has in mind that they are there to make money, and that’s fine and that’s the way it’s supposed to be. But you have to be ready as the compliance officer to kind of play the heavy in that dialogue and from time to time say “Hey, wait a minute, see how this could wind up.”

IMI: What can a compliance officer do to stay in the business line’s loop?

DB: There’s probably only so much compliance officers themselves can do. At a certain point, it’s the responsibility of management to make sure that they’re being included. That being said, I think that good compliance personnel will push to be at the new product meeting or to be involved in the discussions about unusual new customers who are coming in. You should be at least asking to tag along to the meeting of the management committee or whatever the appropriate committee is and trying to put yourself in those positions, expressing interest and wanting to be out there.

If ultimately people won’t include you, at a certain point, as a practical matter, I don’t know what you can do. But the instinct of saying “I want to come to the meeting, I want to hear about it” is a good one.

IMI: What’s more important in a compliance officer, inherent personal traits or knowledge and technical expertise?

DB: I think you can implant the knowledge more easily than you can the judgment and character. If I were starting from zero and creating a compliance function, I would be looking more for character traits.

IMI: Has the job of a compliance officer gotten harder since the Canary scandal broke?

DB: I think you could argue either way. It’s harder in that there’s more attention and certainly the penalties have been more public. It is easier in that people have got to be focused on compliance issues now. People should realize that their enlightened self-interest is to be very, very clean in reputational and compliance things. Hopefully all of this has had the effect of kind of raising the status of compliance people and giving them some additional weight when they say “This is a problem.”

In the best run places, the urge to make money is married very, very closely with the urge to stay out of trouble. In fact, the two are linked directly. If there is some whiff of a compliance issue around you, it’s viewed as something that is very bad business. And it is. To the extent that this type of attention has kind of brought those things together in the mind of the better people in the business line, it should make life easier for the compliance people and make it easier for them to do a good job. To the extent people haven’t had these issues, I hope they are being rewarded for it. To the extent that they have had them, I hope that they’re being rewarded for cleaning up house and making sure it doesn’t happen again. It’s my hope that one way or other this has raised the visibility and status of compliance people.

IMI: But don’t compliance officers now face heightened personal exposure? The SEC just barred a CCO from the industry for life!

DB: It’s true that there have been sort of higher profile negative outcomes for compliance people recently. But I think this is in situations where there’s been outlying, very bad conduct that I think would be obvious to anyone. I don’t think that anyone should be afraid of this sort of thing happening arbitrarily.

The point is that if you have been charged with the compliance role, you [cannot] just abdicate that and become a tool of the business line. There’s a hedge fund in this mutual fund matter where allegedly the compliance officer did nothing but manufacture new corporate entities to facilitate timing under the radar. That was his or her entire job. Someone who is doing that has wholly given themselves over to the business line. Those people have risk just as the business line does. I think that risk is getting more severe in terms of the outcomes. But I don’t think that people who are in good faith doing what can be a very difficult job are in any risk of that at all.

IMI: If you were back in the industry now as in-house counsel, what things might you do?

DB: What [SEC Division of Enforcement director] Steve Cutler has asked everyone to do, which is to identify conflicts [On Sept. 9, 2003, Cutler delivered a speech at an industry conference in which he urged advisers, broker-dealers, and others to scour their firms for conflicts]. I think that is the key. Conflict is like temptation — it doesn’t have to lead to sin. If it’s managed properly, it’s fine. But this is how we structure our review of things: we look for conflicts of interest. We in essence try to find people speaking candidly about how they’ve yielded to them in their e-mails. There’s no way around what Cutler has suggested. You’ve got to identify these things and then you just have to be very active in talking about what the temptations are and how you’re going to about making sure that you’re not yielding to them.

IMI: In investigations and negotiations, what types of lawyers do you find the most effective?

DB: It would be easy to say “Well, the good lawyers are the ones who cooperate and give us everything we want.” I do think that is the better course. When I was in-house, that was the way I handled it. I realize that some people make different tactical calls about how they want to do it and I respect that. If you want to disagree with the stance that the regulators are taking and you want to push back, that’s fine. But it’s not terribly productive to drag your feet on the mechanics of just getting documents produced. I know my office appreciates people who work closely with us and try and get us information. We try and be reasonable and tailor things so that they’re not too burdensome, but if someone doesn’t enter into that dialogue it’s certainly difficult.

IMI: Any tips for people coming in to meet with you and your boss?

DB: This may just be personal, but I always find it to be a very good sign and helpful when an in-house person comes to meet the regulators. I realize that that may not be practical or desirable in every case. But if there is a subpoena or an investigation or an inquiry, and there’s going to be a presentation to us, I think it goes better when there is an in-house person there, as opposed to just outside counsel. Maybe because I was in-house myself.

One size definitely does not fit all here. There may be lots and lots of situations where you just want outside counsel. But if all things are equal and it’s possible, I think it sends a good message to have someone inside, from the control function, to be there. I find that they’re very helpful at meetings. Generally, they really know the business, they really understand what’s going on.

IMI: What’s your take on e-mails?

DB: E-mails . . . this is the future, unfortunately, of all of us lawyers, whichever side we’re on. It seems like we’re doomed to spend the rest of our lives reading these e-mail chains on pieces of paper where you have to go back eight pages to find the beginning and read it forward and then you’ll see another variant of it where it was sent to someone else on the third generation.

We have a small staff and what we have tried to do is be very focused. We send broad subpoenas — as anyone who has received one can tell you — and then we try to follow that up with a relatively focused call saying fine, for right now just give us this specific and, hopefully for us, manageable batch of e-mails. While we’re certainly looking at a lot of it we’ve tried to be as smart as we can in asking for it because it’s very easy to get inundated.

IMI: What lessons do you hope the investment management industry has learned from the scandal?

DB: Parts of the industry had really strayed away from their basic role as fiduciaries and forgotten to whom they really owed loyalty. I think that’s changed a lot [since the scandals broke]. It seems to me that across the industry — even in areas that we are nowhere near touching and will not touch — people in the mutual fund business are asking a lot of hard questions and trying to do the right things as fiduciaries for their shareholders, which is great.

It seems to me that all of this has its own legs [and is] very far separate from the attorney general’s investigation at this point. That’s very positive. I think that one of the things you could have said about the industry is they would never do anything until they were forced to do it. I’m not sure that’s true anymore.

IMI: What’s next in your office’s investigation of the fund industry?

DB: At this point, I don’t expect there to be major new themes in this investigation or revelations that will be shocking to anyone. That being said, we have a tremendous amount of work to do just to finish up the things that we have uncovered. There are a number of [cases] that are going to settle [and] a number that we have so far been unable to settle that we may bring as actions. There are a couple of new directions that we’ll be heading but I think the main issues are out there.