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News June 12, 2006 Issue

CapitalWorks: The Regulators Discuss

To get a better handle on what the SEC was thinking when it brought the CapitalWorks case, IM Insight spoke to Kelly Bowers, senior assistant regional director in the SECís Pacific Regional Office.

Bowers, who was involved in the proceeding, pointed to two take-aways from the case.

First, when "responding to client requests for information or RFPs," advisers should "take care that they are giving full, complete, and accurate answers to the questions." An adviser should not "bring up the last one and put on a new name," Bowers cautioned. "This shouldnít be a block and copy procedure." Bowers added that he was speaking generally, and was not discussing "what happened in this particular case."

Second, Bowers said that "one important component" of an adviserís written policies and procedures is provisions regarding correspondence with clients.

Bowers declined to comment on whether the examination staff already had decided to make an enforcement referral at the end of their August 2004 exam, or whether it was the subsequent RFP sent out post-October 5, 2004 that led to the case. However, he said, the subsequent RFP was "obviously a relevant factor," since it was cited in the SECís order.

Bowers also pointed out that the allegations in the case involved non-scienter fraud (i.e., the SEC brought a Section 206(2) fraud charge, not the tougher Section 206(1) charge, which it reserves for cases involving intentional fraud). "That is important to note," he said.

And, he added, Correnti allegedly "was involved in the conduct at issue. He was not just a head of compliance; he was the head of client service and marketing. Thereís a difference," he said.

Speaking generally, Bowers cautioned readers of the case to "be careful" when drawing implications from the case. "If you take this beyond the facts and circumstances of this case, I think you have to do that with caution."

OCIE director Lori Richards also cautioned against reading too much into the case. "Cases are, by their nature, unique," and are "based on their individual facts," she said in an interview. "All enforcement cases are different."

With that in mind, Richards pointed out several noteworthy allegations in the proceeding.

First, she said, Correnti was responsible for client service and marketing. "In that job," she noted, "he was responsible for the RFP responses that went out." In fact, the order alleged that Correnti gave final approval for eleven of the twelve false responses.

Second, Correnti sent out a false response "after he was explicitly notified by the SEC staff during an exam that the firm had sent out false statements in prior responses to RFPs. He was notified about the problem and nonetheless, went ahead and sent out another false response."

Richards pointed out that the SECís compliance program rule adopting release stated that the SEC would expect an adviserís policies and procedures "at a minimum" to address the accuracy of disclosures made to clients as well as the firmís marketing of its advisory services. "Responding to RFPs," said Richards, "certainly falls within that rubric." In fact, she added, the enforcement case alleged that CapitalWorks had no written policies or procedures relating to client communications at all.

Richards noted that the compliance rule "doesnít mandate that firms have specific procedures covering this or that." Instead, she said, "the rule requires that firms assess the compliance risks inherent in their activities, whatever those may be." If a firm responds to RFPs from clients and prospective clients, she said, one would assume that the failure to respond accurately to requests for information should be viewed as a material risk.

But, she added, regardless of whether a firm identifies a risk on its own, once SEC examiners point out that a problem is actually occurring, the risk is no longer hypothetical. "At that point," said Richards, the firm is "on notice that thereís an actual ó not a possible ó compliance problem." In the CapitalWorks case, she said, the firm, after being alerted to the problem, allegedly did not take steps to fix its compliance program and allegedly sent out at least one additional false RFP. She additionally noted that the compliance program adopting release explicitly stated that advisers should revisit their compliance programs in response to regulatory developments.

So: Should compliance officers panic when reading this case?

"No," Richards said. "CCOs should not overreact to this. We very much understand that most CCOs are trying very hard to do risk assessments to identify conflicts and to implement their compliance programs accordingly. Weíre not going to whack somebody if they make an honest mistake, or if they simply overlook something. This is not that case."

What the case does do, she added, is "reemphasize the need for firms to assess their own individual compliance risks and implement compliance programs accordingly." And, she added, "donít ignore clear signals that your compliance program is failing to prevent violations."