Adequate Supervision Said to be SEC Focus
November 6, 2000
BOSTON - Failure to supervise' is one of the issues investment companies should be most concerned with when facing investigations by the Securities and Exchange Commission, according to industry executives who spoke at the Mutual Fund Compliance Conference of the National Investment Company Service Association of Wellesley, Mass. The annual conference was held here late last month.
Complying with 'failure to supervise' policies, "requires companies to design systems to reasonably detect and deter violations of the law," said James Adelman, associate direct administrator of the Boston direct office of the SEC. It is especially important for companies to pay attention to their internal oversight because a company's failure to do so can get entire companies into trouble based on the actions of individuals with or without the knowledge of the company itself, according to Adelman.
"The commission's viewpoint is [such that] if someone is associated with your firm, the question we ask is, How did this happen and who is responsible?'" said Adelman. "And the first person who is responsible is the president of the entity."
Adelman outlined three principles regarding supervisory responsibility. The first is that heightened supervision is needed for firms with a disciplinary history.
"If we've investigated you in the past, we're going to keep a close eye on what you're doing, depending on what your disciplinary history looks like," said Adelman.
The other principles, that supervisory responsibilities start at the top and must be periodically reassessed, have been conveyed in several recent cases brought by the SEC, Adelman said.
In one case, the SEC, on Aug. 3, released an order imposing sanctions on Dawson-Samberg Capital Management of Southport, Conn. (now known as Dawson-Giammalva), an investment adviser with over $970 million in assets under management.
"This case is a very full statement of the commission's view with respect to supervision and is relevant, not only to advisers, but to the entire industry," said Steven Hansen, a partner at Bingham, Dana & Gould of Boston.
The alleged infraction in the case was an improper use of soft dollars, for which the SEC cited the treasurer of the company, Judith Mack, who was responsible for administering the soft-dollar program, according to the order. The more important aspect of the case was that the SEC also cited the company itself, not just the individual who was responsible, said Adelman.
"Appropriate resources must be allocated to the compliance function," the SEC order said. "...the Commission has stated that a registrant must not only adopt effective procedures for supervision, but must also provide effective staffing, sufficient resources and a system of follow-up and review to determine that any responsibility to supervise delegated to compliance officers, branch managers and other personnel is being diligently exercised."
Adelman also described a case involving Scudder Kemper Investments of Boston, in which a trader was caught forging tickets and lost nearly $17 million. When Scudder realized what had happened, it immediately informed the SEC and paid back all affected clients, according to Adelman. Despite this, the SEC still charged Scudder with not having adequate supervisory systems.
"It's another example of how important it is for companies to have working systems and to constantly be inspecting themselves," said Adelman. "It's not good enough that you didn't know what someone in your company was doing."
The notion that supervisory procedures must be consistently reassessed was also at issue in the Dawson-Samberg case. The order states that the company had adequate procedures in place, but as assets under management increased, the procedures were not changed and were found to be no longer effective. Superficial systems that are not effective will not be an adequate defense when dealing with the SEC, said Adelman.
"People think the most important thing is that you have something written down that sounds good, but what's more important is that the writing corresponds with reality," said Hansen. "You need to test the systems," said Hansen.
In a 1998 case involving Prospera Financial Services of Dallas, the SEC found that the company's procedures designating supervisory responsibility "were ineffective because they failed adequately to assign specific supervisory duties among the parties." "[The company's] written supervisory procedures were also ineffective because they failed adequately to provide for a system of follow-up and review to ensure supervision was being diligently exercised."
"[Companies] have to remember that compliance is fluid, not stagnant," said Adelman. "You should always be assessing and reassessing as things change within your company and within our industry."