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News May 9, 2005 Issue

Keeping it Real: Practical Tips for CCOs (Part 2 of 2)

More highlights from the NRS spring compliance conference:

Mind the gap. The "gap" is the space between whatís been clearly explained by the SEC and what is clearly illegal, explained Ann Oglanian, managing director of Regulatory Management Group, a San Francisco-based consulting firm. In between, she said, are the ethical issues. Despite requests to the SEC along the lines of "wonít you just tell me what you want me to do," she said, the SECís guidance only goes so far, she said. "Thereís this kind of gap between stuff I know I need to do, and then thereís all these issues that arenít actually on the hit list."

Oglanian said that CCOs should recognize their role as the keeper of the firmís ethics, and should not be shy about flagging ethical issues as they arise. "When the crazy idea is on the table," she said, "somebody has to be the one who says, ĎHey, this wouldnít look good on the front page of the Wall Street Journal.í" That job, she said, falls to the CCO. "I would encourage you to not really be shy about recognizing this," she said. When the CEO says "where does it say I canít do that," CCOs shouldnít hesitate to frame the response in ethical terms, she said. Of course, being able to have that sort of frank conversation requires the CCO to first build a relationship with the firmís business people "where they understand that you are on the team," she added. "If you just say ĎNo, you canít do it,í itís not good enough. You have to say why not."

How do you know when you are staring down an ethical issue? Answer: If itís not prohibited, but "it would look bad." Oglanian urged CCOs to listen to their inner regulator: "If you are thinking ĎThereís something not right here, youíre probably right." Other voices to listen to include the ones that say "Youíre going to get in trouble" and "This is not going to smell good."

Another way to "mind the gap" is to consider how a proposed activity would look if made public. Oglanian called this the "transparency touchstone." She suggested the following test: "If you shine a light on it and make it transparent, what is it going to smell like?"

Bank of America lawyer Cynthia Fornelli added that even if a proposed practice is acceptable from an ethical perspective, a firm still may want to avoid it because of the appearance of impropriety. Something can be "really well intentioned," said Fornelli, "but you really have to step back and say ĎHow is this going to look, can I explain this to my mom?í"

Thereís also the Big Brother test. As Oglanian put it: "if the SEC was watching you or if the Wall Street Journal was watching you, would you do it?" Itís not just whether itís right or wrong, she added, "itís the perception of whether there is something amiss."

Be true to yourself. "If you are one of those people who thinks your firm should sell the heck out of every product, you should not be the firmís chief compliance officer," said Dechert counsel Elizabeth Knoblock.

Oversee your third party service providers. Your firm may be grappling with questions about whether certification is enough, or whether an actual on-site audit must be conducted. Oglanian suggested that firms consider the following: at the end of the day, if there is a problem, whose name is going to be in the Wall Street Journal? She analogized the due diligence process to the RFP process. "You have to figure out what the subadvisers [and other service providers] are up to," she said. Oglanian suggested appointing a business manager to be charge of each outsourced relationship. "Itís not like you outsource it and then you forget about it." At the end of the day, she said, "itís still your job."

While Oglanian noted that some firms may ask their third party service providers to report their serious compliance deficiencies, Fornelli noted that such reporting could raise issues of privilege. However, Oglanian suggested that a lawyer be retained to collect and disseminate the violation reports. At a minimum, said Fornelli, have a verbal conversation about what happened and "encourage a lot of dialogue." While a service provider may naturally have "a little hesitancy" to provide a detailed accounting of what happened, Fornelli said that firms should "test and probe" nonetheless. When a service provider reports a violation, she suggested that firms ask questions along the line of: "How did it happen? How did you discover it? What did you do about it?" If you learn that there have been changes made to the service providerís policies and procedures, ask what prompted them, suggested Fornelli. And, added Oglanian, be sure to ask: "Why will this never happen again?"

Fornelli said that sheís seen contracts where reporting of controls and obligations becomes a contractual obligation on the part of the service provider. Oglanian suggested that firms sit down with new service providers and "discuss this at the table" before they are retained. Given the focus on service provider oversight, she added, "this should be very familiar to them at this point."

Get your stories straight. Fornelli suggested that firms print out their website, their Form ADVs, and their advisory contracts, and make sure they are consistent and reflect what the firm actually is doing.