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New Financial Regulations to Create Unprecedented 'Sea Change' at SEC

Executives Warn: The Enforcers Are Coming


BOSTON -- Mutual fund companies must stay on top of their compliance programs, particularly because Congress is likely to pass new financial regulations, executives warn.

"Regulation writing is about resolving tensions and balancing purposes,' said Michael Novey, associate tax legislative counsel at the Office of Tax Policy at the Department of Treasury, speaking at the National Investment Company Service Association's East Coast Regional Meeting here.

"Our task is to implement legislative purpose, recognizing that Congress' acts ought to be workable," he said. "There is a tremendous amount of misunderstanding about many of the proposed regulations."

For example, proposals on cost-basis reporting have been under consideration since the early '90s, Novey said. Under the latest version, funds and investors alike will no longer have to rummage through a mass of transactions to determine the value of assets between their time of purchase and sale. However, putting everything together can create its own set of complications, and cost-basis accounting is likely to be a challenge in 2010.

"We like to refer to cost-basis as putting things into a blender," Novey said. "What happens when you want to take something out? You can't reconstitute the fruit once it's gone into the blender."

Novey said the financial industry can help regulators limit confusion by participating in the public comment periods each new regulatory change must undergo. "We want to hear from you," he said, adding that the deadline for comments on cost basis is Feb. 8.

Up in Arms

The recent, exceptionally tough bear market has infuriated millions of Americans and given legislators a mandate to reform financial regulations. The wish among many leaders for slowly, carefully created changes that can stand the test of time may not be enough to satisfy the public's bloodlust for accountability now.

"I have never before seen a pro-enforcement environment like today," said Thomas Biolsi, a principal in the regulatory consulting practice at PricewaterhouseCoopers. "We are seeing a much closer alignment of regulatory divisions, signifying a fundamental change in the relationship between regulators and the financial services industry."

Biolsi said the "sea change" already occurring at the Securities and Exchange Commission will substantially alter the relationship fund companies have with that agency.

"We have seen a dramatic increase in the number of enforcement actions by the SEC," said F. Joseph Warin, head of litigation practice at Gibson, Dunn & Crutcher. "The recent financial crisis has elevated the importance of risk management and exposed new areas of risk. The government continues to enact new regulations and pursue aggressive enforcement agendas."

Digging for Problems

Warin said regulators expect companies to take the initiative to review their own programs and conduct their own internal investigations in the wake of major incidents in their industry, without having to be prodded by authorities. "If somebody in your industry has an issue, you should look for similar problems in your own company," he said.

"Companies need to integrate their various compliance programs," said Amy Goodman, a partner at Gibson Dunn, adding that programs covering health, safety and welfare, discrimination, harassment, anti-money laundering, false claims and trade regulations can all fall under the same compliance umbrella.

While it's impossible to predict every possible problem, a solid compliance program can show a court of law that steps were taken in good faith to prevent the problem, should something go wrong.

"Courts will look to see if the board of directors followed a process in making their decision," Goodman said. "Directors can be held personally liable if they failed to implement a program."

She said the board doesn't need to be briefed on every single issue or problem, but directors need to be informed well enough to be able to see if a trend is developing. The role of boards in risk oversight is to set the tone and culture, she said, and speeches and presentations by CEOs can effectively demonstrate the tone at the top to regulators.

"If you cut compliance and then have a problem, the government will have very little sympathy for you," said Debra Wong Yang, a partner at Gibson Dunn.

Insider Trading

"We will see more aggressive attempts to catch wrongdoers, including the implementation of devices like wiretapping," said Michael Gozzillo, asset management compliance officer at TIAA-CREF. "We are seeing a lot of pressure from regulators on insider trading in particular, and expect to see more cases in 2010."

Insider trading is trading that takes place by someone with privileged, non-public information, done to the detriment of investors who don't have that information, he said.

Material information like earnings and advanced predictions can be considered inside information if there is a substantial likelihood that a reasonable investor would find it important, but it starts to get fuzzy from there, Gozzillo said.

"What if you post the information on your website?" he asked. "A lot of firms are out on Facebook and other mediums" like Twitter. "Is that public?"

Gozzillo said firms can be cited by the SEC for having insufficient policies and procedures, even if they don't have a problem.

To prevent this, he suggests firms craft a detailed compliance policy that clearly defines and prohibits problems like trading on insider information. Firms should designate a point person for insider trading questions and create information barriers around certain people and departments, he said.

Firms should try to develop effective training that ties these issues into the real world and maintain restrictive watch lists of employees, Gozzillo said.

"You can't underestimate the importance of advanced e-mail surveillance," he said.

(c) 2010 Money Management Executive and SourceMedia.