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News July 20, 2015 Issue

SEC Wants More Outsourced CCO Information

The SEC may soon be able to compile a searchable database of third-party chief compliance officers, including the names of the advisers and funds that retain them.

Buried in its May proposals to update adviser and investment company reporting requirements are items asking advisers and funds for the names of their CCO and whether that person is an employee or is paid by an external service provider.

"Item 1.J. of Form ADV currently requires each adviser to provide the name and contact information for the adviser’s chief compliance officer," the SEC says in the commentary to its proposed release for adviser reporting changes. "We propose to amend Item 1.J. to require an adviser to report whether its chief compliance officer is compensated or employed by any person other than the adviser (or a related person of the adviser) for providing chief compliance officer services, and, if so, to report the name and IRS Employer Identification Number (if any) of that other person."

The proposed release commentary for investment company reporting changes contains similar language. "The fund would be required to provide the chief compliance officer’s name, CRD number (if any), address, and phone number, as well as indicate if the CCO has changed since the last filing," the proposal states. "If the fund’s CCO is compensated or employed by any person other than the fund, or an affiliated person of the fund, for providing CCO services, the fund would also be required to report the name and Employer Identification Number of the person providing such compensation."

What the SEC might do with the information

Does the Commission think there are problems with advisers or firms relying on third-party CCOs? In some cases, it apparently does. "Our examination staff has observed a wide spectrum of both quality and effectiveness of outsourced chief compliance officers and firms," the agency says in its proposed rule for advisers. "Identifying information for these third-party service providers, like others on Form ADV, would allow us to identify all advisers relying on a particular service provider and could be used to improve our ability to assess potential risks."

"This new requirement would provide staff with information on all fund CCOs and would allow the staff to contact a fund’s CCO directly," the SEC said in its proposed rule release for funds.

The net result of the SEC gathering this information is that the SEC would be able to create a searchable database of third-party CCOs. "Once the SEC staff puts that information into its systems, the agency has the capacity to search it," said Willkie partner James Burns. "If there is a problem at one adviser, the SEC could find others who use that CCO and look for grounds to examine them."

Sidley Austin partner Joshua Rovine said that he is not deeply troubled by the proposed change. "Someone should be the outsourced CCO for only as many advisers or investment companies as he or she can handle," he said. "If I were an adviser and my outsourced CCO was in trouble from his or her work with another adviser, that would give me concern."

What advisers and funds should do

"Advisory firms and funds that think about using an outsourced CCO will need to think about the quality of the services being performed," said Burns. Get references from peers, gather the views of outside counsel, interview the prospective third-party CCOs to learn just "how well they know the business," he said. Get answers to information that SEC staff might ask, such as how an outsourced CCO, operating remotely, can create a culture of compliance at the advisory firm.

What an adviser should remember, regardless of whether this change is adopted, is the importance of doing careful due diligence on any outsourced CCO that it is considering retaining, Rovine said.