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SEC Expected to Put CCOs to Acid Test

Barely has the ink dried on what many in the industry, admittedly, are calling the single most important new fund regulation of 2004 and already PricewaterhouseCoopers is predicting a new tsunami wave of sanctions, within months not years, against these newly appointed chief compliance officers that will define the boundaries of industry practice.

"Everyone in the industry is waiting for the first SEC enforcement case to be brought against a chief compliance officer or a board member because, quite frankly, that is going to set a practice and set the standard in the industry," said Anthony S. Evangelista, a PricewaterhouseCoopers partner and director of the regulatory compliance practice of its investment management industry group.

"That first enforcement case will happen," he added. "The SEC has cast around in the water, and they are already fishing around. They are calling registrants and asking questions."

Lloyd E. "Chip" Voneiff, a national leader in PricewaterhouseCoopers' investment management industry group, agreed that enforcement action is inevitable. "We are months rather than years away from our first enforcement case," he said. "This is an all-new model. No one expects this to be perfect."

Last December, the Securities and Exchange Commission adopted a rule requiring that all mutual fund companies appoint a chief compliance officer by Oct. 5. Analysts said the rule, which enforces the Investment Company Act of 1940 and the Investment Advisors Act of 1940, also requires companies to adopt guidelines for federal regulatory compliance.

David J. Harris, a partner in the financial services group at the Washington law firm Dechert, said that chief compliance officers were taking the jobs without knowing what, exactly, they must do to satisfy regulators. "You have put a bull's-eye on the back of these compliance officers if there is ever a problem," he said. "Before, the responsibility was diffused. Now, it is concentrated."

Harris added: "Basically, you are putting someone on duty to watch without knowing what specifically they are looking for. They have created a scapegoat." Voneiff said most companies will spend the next 12 months monitoring and testing their policies and procedures to ensure compliance. "Big financial institutions are carefully assessing their organization," he said. "They are making sure they have the policies and controls in place. They are trying to be preventative right now."

Evangelista said that although the regulations have been codified, it will be difficult for companies to handle compliance confidently before seeing what the SEC thinks worthy of sanction in other companies. "Getting the job as a chief compliance officer is easy. The next step, compliance, is hard," Evangelista said. He added: "This is not a one-size-fits-all problem. This all really depends on your organization."

The SEC is still trying to resolve a lot of compliance issues, including brokerage practices, soft-dollar payments and financial reimbursements to vendors. Voneiff said the key to being safely compliant is full disclosure. "Firms have to dig down and look at everything," he said.

Large investment firms are currently creating internal structures to deal with compliance and are trying to create guidelines for their trading and brokerage practices, he said. Smaller fund companies are turning to outsourcing firms to handle compliance. Bank of New York, for instance, has developed a Web-based product to support fund company compliance. The service, CCOaccess, gives chief compliance officers reports on post-trade compliance, market-timing surveillance and fair valuation.

Joe Keenan, a managing director and the head of product sales and marketing strategy at Bank of New York's global fund services unit, said it is premature to predict the service's acceptance in the marketplace since it was introduced only about six weeks ago, although the initial response has been positive.

Companies are already planning to spend more for compliance, according to a PricewaterhouseCoopers Management Barometer Survey. It found that 51% of U.S. and European multinational companies expect compliance spending increases averaging 23.4% during the next 12 to 24 months (see MME 11/15/04).

Dan DiFilippo, the PricewaterhouseCoopers global leader for performance improvement and U.S. leader for governance, risk and compliance, said the companies surveyed spent 6.16% of their total budgets on compliance and the 23.4% increase within two years applies to that spending share. He said he does not think companies are preparing for a new wave of sanctions so much as they are just trying to be proactive.

"Everyone is looking at their compliance program and trying to find places where they might stumble," he said. "They want to find out how they can avoid exposure from similar situations," that is, practices of their own that, in another company, have prompted regulatory action. "I don't think they are anticipating more regulations or more scandal as much as they are taking stock in where they are."

Fund companies are very concerned about compliance, especially among the third-party service companies they hire. A survey by PricewaterhouseCoopers' investment management group said 64% of fund companies are concerned about overseeing service providers, 15% about securities trading and brokerage practices, and 9% about principal underwriter activities. Voneiff said it is clear banks, fund companies and other financial services firms are concerned about compliance issues. Three hundred directors from 80 to 90 fund companies attended PricewaterhouseCoopers' annual conference on compliance and governance in New York this month, he said, compared with 200 directors last year.

"Everyone understands that these rules are new to the industry and there will be some growing pains," he said. "We are all going to carefully watch how this all gets implemented."

Matt Ackermann is a reporter for American Banker.