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News July 5, 2004 Issue

OCIE Director Sheds Light on Compliance Program Issues

Last week, OCIE director Lori Richards discussed several issues under the new compliance program rule, in a speech delivered at an Investment Company Institute conference by OCIE general counsel John Walsh.

While her (his?) remarks were geared to fund companies, non-fund advisers may find them informative, as well. The highlights:

OCIE Will View the CCO as An Ally. "We expect the [CCO] to be open, honest, and candid with us about issues that arise," said Richards. She said that SEC examiners will speak "often" to the CCO, "utilizing her knowledge to more completely understand the fundís compliance program, to hear concerns, and to understand emerging issues and the ways in which they are being handled." She said it is likely that exams will begin with a discussion with the CCO.

Think Twice Before Mixing Your CCO Up With Your Lawyers. Richards said that she "would not automatically assume" that the CCO position should be placed within a firmís legal department, or report through the firmís general counsel. Intertwining the duties of the CCO with corporate legal duties may create conflicts in the implementation, as well as in the SECís examination, of the compliance program, she said. If a firm decides to have its CCO report to Legal, said Richards, "counsel will have to clearly articulate instances of client privilege and show great effort to segregate any dual responsibilities."

Richards noted that routine compliance monitoring is not subject to attorney-client privilege. She also stated that reports required under the federal securities laws must be provided to SEC staff for examination and are not subject to attorney-client privilege, work product doctrine, or other protections.

If Your Outsourced CCO Isnít Effective, Youíll Be the One on the Hook. Richards acknowledged that the fund compliance rule "does not preclude outsourcing," but went on to state that she would be "wary about whether a compliance Ďrent a copí could really be up to the task." She questioned whether a New York-based CCO would be able to effectively implement and monitor a compliance program in California. And, she asked, "Is it reasonable for a [CCO] serving 10 different fund complexes to effectively service them all?" That, she said, was a decision that must be made by the fundís board. But she warned that if the compliance program is not effective because the procedures are not implemented effectively or the CCO is not sufficiently involved or does not have sufficient expertise, "your fund firm will not be in compliance with the rule."

Bickering and Dithering Isnít the Same as Coercing. Richards clarified that "normal give-and-take discussions" within a firm over whether a law has been violated or the merits of a new compliance procedure should not be construed as "undue influence" of the CCO. "Iím sure that the fundís board and the Commission will use the guidelines of reasonableness and honest intentions" to determine whether the CCOís independence was being subverted, she said.

Other CCO Issues. Richards said the CCO should understand not only the regulations, but the "products and services offered by the firm, the nature of the services provided by service providers, and the firmís operational and compliance structure." She suggested that a CCOís compensation be structured in a way that reinforces or incentivizes the CCOís objectivity and motivates her to perform. She suggested a number of performance factors (one example: Is the firmís compliance program structured to, and does it in fact, prevent, detect, and correct violations?) She did not, however, suggest specific compensation structures.

A To-Do List. Richards asked firms to:

  • question past practices, even those that while technically legal, may not be ethical;
  • identify actual and potential conflicts of interest;
  • engage in dialogue with all business units and service providers about their activities;
  • review disclosures given to clients;
  • inventory the firmís obligations under the securities laws and disclosures;
  • match that inventory to the firmís policies, procedures, and controls;
  • throw out practices, policies, and procedures that did not serve;
  • adopt new policies and test them; and
  • educate employees on conflicts, on the culture of the firm, and their responsibilities within it.

Richards urged the industry to see the rule as an opportunity, rather than a burden. "If you view this rule as Ďjust another compliance obligation,í if you stage compliance with the rule for show, if you take only minimal steps, if you do not believe in its importance, you will fail to seize the opportunity it presents," she said. "We at the SEC will not tolerate a perfunctory show of compliance."