Continuing this week on the changes to the Form ADV is a revision to Item 1.J that lists the chief compliance officer.
The new Form ADV will require a registered investment adviser to disclose whether the firm’s CCO is compensated or employed by someone other than the adviser. That is, the SEC wants to know if the CCO is outsourced.
The SEC has previously noted that it has observed a wide spectrum of quality and effectiveness with outsourced CCOs. Clearly, having an outsourced CCO will be a risk factor when deciding to examine a firm.
I think that is true in part, but depends on the outsourcing itself.
I believe the SEC is looking for trends and will be able to see which firms do a good job of acting as an outsourced CCO and which do a bad job. If the SEC sees a trend that a particular outsourcing firm is doing a bad job, it will certainly take a closer look at the advisers that used that outsourcing firm.
The disclosure will work to identify both the good outsourcing firms and the bad outsourcing firms in the eyes of the SEC.
There is one small flaw in the disclosure. That is the instance in which the outsourced CCO is not employed by a firm, but is self-employed. The new question asks for the name of the “person” (corporations are people too) and the IRS EIN that employs or compensates the outsourced CCO. The self-employed outsourced CCO would not disclose the other firms that have hired him or her. And the person would definitely not want the SSN to be used as the EIN.
Sources:
- Form ADV and Investment Adviser Act Rules Release IA-4509 (.pdf)
- Separately Managed Accounts
- The SEC Wants To Know About Your Social Media