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Small Fund CCOs Grapple With New Role: Many Turn to Outside Legal Counsel


With a full 12 months of new compliance experience under their belts, fund industry executives and chief compliance officers of small or niche fund groups have had some time to reflect on their experiences and added workload.

So what's the last year been like?

Last year "was the year from hell, but 2005 was not as bad," said one Ohio-based chief compliance officer, who spoke on condition of anonymity. "The days are longer, the nights are shorter, and weekends don't exist. It's been a gruesome and grueling experience," he added.

This compliance officer, who took on the dual role of both the chief compliance officer of the investment advisor as well as the mutual fund group, said that the time he spends on compliance functions had ratcheted up from about 5% to 10% of his time before the Securities and Exchange Commission's new requirements, to 50% to 70% of his time now.

The majority of that time was spent preparing a policies and procedures manual for both the advisor and the funds, a process that he described as "rigorous." Seven to eight new pages detailing those policies and procedures have been added to the board books that the boards of directors must review. Now that those have been done properly and are securely in place, "next year we will just fill in the blanks," he added.

Learning as You Go

"Twelve months ago, it seemed like a lot of the rules would be onerous and there wasn't a lot of SEC guidance," said Matt Hemberger, who, one year ago, was appointed as chief compliance officer of the Arbitrage Fund, which is the sole mutual fund managed by Water Island Capital of New York. "But as you go through, things fall into place," he said. "It's a role you kind of have to grow into."

It also helps to seek out guidance from others, Hemberger said. "You need to be inquisitive and creative and ask questions," he said. He noted that he often asks fund counsel and peers that he meets at conferences how to handle certain compliance issues.

Water Island Capital also this past July changed its back-office service provider to one that offers enhanced technologies and a compliance component, complete with a compliance officer who is available if the need arises, Hemberger said.

Getting Counsel from Counsel

Relying on guidance from legal counsel can be the way to go for a small fund firm with limited resources. But there is a steep price to be paid. The chief compliance officer from Ohio confirmed that his firm's legal costs have tripled. "You lean heavily on your legal counsel who tries to help," he said.

Perritt Capital Management of Chicago is about to hire outside legal counsel to assist with its compliance processes on an outsourced basis, said Michael Corbett, president of the two Perritt Funds, which have a combined $400 million. Corbett also serves as the chief investment officer to the advisory firm, which has another $100 million in separate account assets.

Before the recent slew of compliance mandates, Perritt had one employee who handled the compliance function as 50% of his job. Since then, that compliance officer, who previously handled back-office processing, was appointed to be the chief compliance officer and now handles compliance on a full-time basis. The firm has since added one other employee to help with compliance, and he spends about half of his workday assisting the CCO.

Corbett said he is thankful that his funds have tripled in size over the last three to four years. That added bulk has helped the fund adequately meet the additional compliance processes, paperwork and reviews that are necessary. "I don't think it would have put us out of business" had the firm not grown as rapidly, he said. "But it would have been somewhat of a problem had we been smaller. If our assets hadn't grown, our shareholders would have been impacted."

The extra compliance burden, including the steeper salary paid to the chief compliance officer who was promoted, has had a greater burden on fund shareholders, but the increase is not meaningful, he added.

Compliance Costs

Costs are definitely a consideration for small firms sporting thin or non-existent profit margins.

There are extra costs incurred with the increased compliance, agreed Hemberger of Water Island Capital. "It's hard to reduce our [fund's] expense ratio" in light of these added costs," he said.

"Ultimately, the consumer always pays," said Don Yacktman, president and chief investment officer of Austin, Texas-based Yacktman Asset Management, which manages two mutual funds.

But the real cost of the added compliance responsibilities on mutual fund and investment advisors is perhaps beyond measurement. "The small firms are paying for the sins of the large firms," Yacktman said. Moreover, the array of new compliance mandates raises the barrier of entry for investment firms and encourages quicker consolidation, Yacktman added.

"The SEC added another layer in an attempt to regulate honesty, which I'm not sure can be regulated," Yacktman noted. New requirements, like the added compliance burden, are common overreactions that Yacktman said are akin to "shooting a mouse with an elephant gun." But in the end you do what has to be done. "You deal the best with what you've been dealt," he summed up.

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