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News November 22, 2004 Issue

Time to Plan Ahead for Compliance Program Annual Review?

Nawh . . . maybe after the holidays.

"I don’t really think people are thinking about the annual review now," said Crowell & Moring partner Stephanie Monaco. Instead, she said, they are currently "immersed" in spot-checking, sampling, and learning about compliance issues in isolated, identifiable areas. They are "trying to fill holes" and checking to see that what they’ve written in the pre-October 5 scramble make sense. The first annual review, she said, could ultimately turn out to be a "culmination of all these intra-year spot checks."

Schulte Roth and Zabel partner Terry O’Malley said that he’s only recently received a client question on the annual review process, and agreed with Monaco that it did not yet seem to be a front-burner issue for CCOs. "If they aren’t cleaning up some of the stuff they’ve identified [pre-October 5], I think they are just catching their breath."

"People are putting it on their agenda for early to mid-2005," reported Jeff Morton of Adviser Compliance Associates. Right now, he said, they are doing a "one final run-through" of their compliance programs "to make sure they are doing what they are saying they are doing."

On that score, here’s a tip from Monaco: review any new committees that have been established to confirm that they understand their objectives, are actually meeting, and are memorializing their meetings with minutes or notes. "Everybody’s filled up with all these committees," she said, noting that it could be "a disaster in the waiting" if SEC examiners discover that the committees exist only on paper.

A few things to consider now that might make the annual review process easier down the line:

Pick your due date. Take the date that your firm formally adopted its compliance program, add 18 months, and that gives you the outside deadline for completing your first annual review of your compliance program. If, for example, you adopted on October 5, 2004, you have an April 5, 2006 completion due date, at the latest. However, as long as the review covers a 12-month period, you can complete it earlier. Firms might want to consider whether, going forward, a December 31 anniversary date for the annual review (or other date) makes more sense. Some firms may find that it is more efficient to complete the annual review and make any required operational or procedural changes before beginning the Form ADV update process, rather than doing so concurrently with the ADV update (the ADV update, for firms with a December 31 fiscal year end, is due March 31).

Other firms will find that their year-end already is crowded enough as it is. Because of year-end business, O’Malley predicted that many advisers will attempt to wrap up the annual review in January or February. "I would see them doing it between January 1 and the time they get their ADV filed." Doing it early in the quarter "obviously helps set them up for any changes they would have to make on their ADV," he added.

Develop a road map. There is no requirement that firms wait until the deadline draws near to begin their reviews, or that they wait and do the whole thing all at once. Many CCOs may find that it makes sense to break the annual review project down into chunks and address the various pieces on a quarterly or even monthly basis.

Keep track of things during the year. Go ahead and create running "scratch lists" of issues, which can be updated throughout the year:

  • changes in business activities of adviser;
  • changes in business activities of affiliates; and
  • changes in Advisers Act or rules.

Keep in mind that those lists will be subject to review by SEC examiners under Rule 204-2(a)(17)(ii).

Think of what the final product will look like. This seems to be the biggest question out there: Should non-fund advisers plan to prepare a written report as part of their annual review?

Under the Advisers Act rule, there’s no requirement to do so, although any records documenting the annual review must be kept as part of the firm’s books and records (see Rule 204-2(a)(17)(ii)). If a report is prepared, it should be done so with the expectation that it will be read by SEC examiners.

O’Malley suggested that firms create a matrix covering each of the areas in the firm’s compliance program. For each area, the matrix could briefly indicate how the area was reviewed, which personnel were met with and when, what issues were identified, and any follow up action taken, etc.