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Compliance Rule Deadline is Only the Beginning


From Sarbanes-Oxley reforms to anti-money laundering rules to the USA PATRIOT Act, the rate of regulatory change within the investment management industry has dramatically increased over the last several years. Mutual fund managers now find themselves dividing their time between meeting the requirements of new laws and maintaining their primary focus of managing and growing assets.

The Securities and Exchange Commission's Rule 38a-1, also known informally as the compliance rule, is one of the most important regulations recently enacted to protect the interests of mutual fund investors. In December 2003, the SEC adopted Rule 38a-1 under the Investment Company Act of 1940 and required mutual funds to be in compliance with the new rule by Oct. 5, 2004.

Over the past few years, service providers have played a crucial role in helping fund companies meet new regulations, and the response to Rule 38a-1 was no different. Many firms spent much of 2004 preparing for the deadline, taking advantage of compliance support programs offered by service providers, since a substantial amount of work had to be completed in an accelerated time frame and simply could not be accomplished in-house.

Nonetheless, compliance with Rule 38a-1 is still an ongoing endeavor that requires a robust suite of services to assist a CCO, a fact somewhat overshadowed by the focus on the rule's initial deadline of Oct. 5. ICI President Paul Schott Stevens was recently quoted as saying that of all the recent regulations and rulings, "the compliance rule may have the greatest long-term impact." For a compliance support program to be effective, a provider should offer services continually throughout the year with formalized reporting on a quarterly and annual basis. Such an offering should also be flexible so that a fund company can select all or any combination of services to create the ideal solution to meet their specific needs. By having the ability to pick and choose particular components of the offering, fund companies can get the best possible value and pay only for the services they need.

Rule 38a-1 states that within 18 months of adopting a compliance program, a fund company must conduct the first of its annual reviews to ensure the adequacy and effectiveness of its policies and procedures. Compliance support service providers can assist the CCO in preparing the written annual report to the board that includes the operation of the fund's policies and procedures and those of its service providers. Of course, any compliance issues uncovered in the course of normal business or in preparation for the 18-month review must be addressed immediately, and fund companies cannot wait for the annual deadline. A compliance support service provider can help a fund company tackle such issues if they arise and address them in a timely manner.

Service providers typically devote a great deal of time to monitoring the latest in industry best practices, trends and regulatory matters. CCOs must be aware of these developments, and compliance support service providers can help by offering knowledgeable, dedicated personnel to hold one-on-one meetings with the CCO to present written updates and answer questions on a regularly scheduled basis.

Compliance support service providers should also offer additional tools and resources to further assist a CCO in keeping the company and the board well-versed on the most current regulatory matters, leaving them more time to focus on managing the fund. By harnessing the latest technology advances, providers may offer a convenient, secure Web-based tool enabling firms to access their key fund and regulatory information from a single source. This "fund library" can house the latest incarnations of a fund's compliance procedures and summaries, as well as those of its service providers. To be truly effective, such a library should also contain quarterly regulatory updates, current prospectuses, and past board and committee meeting minutes.

Finally, as a compliance support service provider often furnishes other services to a fund, they should offer all Rule 38a-1 services through one central contact to reduce risk and provide consistency. This affords the CCO a direct link to the provider's policies and procedures as they relate to additional service offerings that fall under the jurisdiction of Rule 38a-1.

Certainly, there are future regulations ahead, and fund service providers, as an integral part of a fund's operations, will play an increasing role in helping funds meet those requirements. Those providers that have established a strong compliance support program with the adoption of Rule 38a-1 will be well poised to assist fund companies over the next 18 months and best positioned to expand that role as further regulations are introduced, allowing fund companies to concentrate on the business of managing client assets.

Neal J. Andrews is senior vice president and senior managing director, fund accounting and administration, for PFPC.