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News January 31, 2005 Issue

How To Sniff Out a Rogue Employee

Some suggestions to consider:

  • If one person is responsible for reconciling your firmís account management system against your custodial data, make sure that someone else periodically spot checks those reconciliations to make sure they are being done, and are being done correctly.
  • Adopt a policy requiring that that two officers of the firm review and approve, in writing, account withdrawal or transfer instructions for transactions greater than a specific amount. Consider the ramifications of informing your custodian of this policy and/or asking that your custodial agreement be amended to reflect this policy.
  • Instruct your custodian that if they detect suspicious activity in an account, they are to contact a senior manager in the firm, in addition to the employee with day-to-day responsibility over the account.
  • Consider whether your firm is adequately staffed, and whether any one employee is given too much leeway within the firm. In its suit against Applied Financial Group, the Baker Audio Profit Sharing Plan noted that the adviser, which managed more than $120 million in client assets, "knew or should have known that more than five employees were necessary to manage investments and monitor transactions of its client accounts."
  • Periodically test to confirm that trading assistants are properly implementing portfolio managersí instructions. One way to do this is by reviewing transactions reported on custodial statements against the portfolio managersí instructions.
  • Run exception reports to flag suspicious transactions, such as transfers and transactions above a specific amount.
  • If your CCO serves a dual role within your firm (such as a trader or portfolio manager), appoint someone else within your firm to test how the CCO is performing his or her functional activities (all CCOs should have independent review of their personal trading and other general compliance related matters).
  • At a minimum, periodically sample and review incoming and outgoing correspondence from a variety of firm participants, whether by mail, e-mail, or fax.
  • Review the firmís checks cut, and investigate out-of-sequence checks.
  • Establish which advisory clients receive custodial account statements directly from your firmís custodian. Establish a procedure for changing the mailing address for those account statements (IM Insightís been told that Longo set up a mailbox at Mailboxes Etc. and directed Schwab to send some of the account statements there).
  • Lastly, if one of your employees starts living apparently beyond his or her means, get nosy. Baker Audio claimed that during the four years that Longo allegedly was embezzling funds, she bought "a million-plus" home and a vacation home, began building a beach house, and traveled and shopped extensively. (Of course, CCO salaries are going through the roof these days . . .)