Funds Seeking Board Approval for CCO Short on Time
August 2, 2004
It's crunch time for mutual funds. With the Oct. 5 deadline for mutual funds to designate a chief compliance officer just two months away, fund executives are scrambling to get their policies and procedures in place. The question is are they ready?
"That's the acid test question everybody's asking," said Tony Evangelista, a partner at PricewaterhouseCoopers and a former chief accountant with the Securities and Exchange Commission.
"Some best-in-class shops had a very robust set of policies and procedures, so they were well prepared for the rule when it was adopted last December. And then, of course, there were some at the other end of the spectrum that were caught by surprise by the magnitude and totality of this new rule. It really mandated a whole new cultural philosophy for some of these companies," he said.
Amid efforts to get up to speed with new regulatory requirements, many fund firms have encountered significant challenges. For example, overseeing service providers and ensuring that trading and brokerage procedures meet regulatory standards were identified as mutual fund executives' chief concerns, according to a recent PwC survey. The Big Four accounting and consulting firm polled 200 mutual fund executives during compliance forums the company held in Boston, Denver, New York and San Francisco in June. Among the attendees were compliance officers, fund directors, legal counsel and auditors.
PwC found that 30% of the participating fund executives were primarily worried about evaluating the policies and procedures of their service providers. Meanwhile, 28% of the respondents identified brokerage oversight as their biggest compliance concern. The results support the notion that overseeing the distribution channel will be the most difficult and complex elements of the compliance program to monitor. And given the ongoing mutual fund trading scandal and related scrutiny of such brokerage practices as revenue sharing, soft dollars and best execution, getting to the bottom of trading policies has become a serious cause for anxiety at many fund shops. Further, presenting the policies and procedures of service providers to the board of trustees for approval is a tall order, not to mention an unprecedented move for mutual fund companies, Evangelista noted.
Some firms are hopeful that the SEC will extend the deadline for the compliance rule, but that's not a likely scenario, according to Evangelista. He believes that the SEC has provided guidance on the truly important aspects of the compliance rule but that it is likely to take an accommodative stance when it comes to regulations that are perhaps less meaningful. "If you put forth a good faith effort to comply with this rule and do so in a timely manner, I think they'll understand," Evangelista said. "I don't think they'll be looking for compliance with all aspects of federal securities laws on day one. But if [a firm] did file for an extension, it would be the first stop for the SEC on Oct. 6."
According to the survey, 70% of fund complexes have named a CCO, but only 38% have had their candidates approved by their fund's board. "That's a large gap in my mind," Evangelista said. "To put a chief compliance officer into a shop in the middle of August and expect them to put together a cohesive and comprehensive package for board approval for a September board meeting and an October deadline, is a pretty large undertaking." The lag in board approval likely stems from the fact that appointing the individual was the exciting part of the process, one that fund firms were eager to put in motion. However, getting board approval of that individual's qualifications and compensation package is a much more time-consuming and difficult task.
As far as who they are picking for CCO, many funds appear to be leaning toward experienced insiders. Nearly half of the survey's respondents said that extensive knowledge of the fund family, its advisors and service providers was the most critical factor in choosing a candidate. Twenty-nine percent said that past experience as a compliance officer was most important. To a much lesser degree, some thought operational and legal experience were key attributes.
Many industry insiders have complained that the new rule will have significant cost implications. Selecting a competent CCO will not come cheap, given the position's heightened profile and potential liability. Fund firms are already bearing the costs associated with obtaining legal counsel and outside consultants to assist in the compliance process. In addition, improving technology and back-office controls will be added compliance expenses, Evangelista said.
That raises another important question: Who will bear the cost? Fund executives were almost evenly split over who would pay for the funds' chief compliance officer, with 31% saying that the funds themselves should shoulder the load, 29% saying the advisor should front the money and 37% saying a combination of the two. That suggests that nobody really knows who is going to pony up the dough for the compliance chief. Further, will that cost be passed on to the fund shareholders? These are the types of decisions fund boards will have to make in the coming weeks.