ACA Compliance sponsored this webinar on Thursday. Brian L. Rubin, Partner, Sutherland Asbill & Brennan LLP was the presenter. These are my notes.
Section 203(e) of the Advisers Act:
If an investment adviser fails to reasonably supervise an employee or any other person subject to the adviser’s supervision, and that person violates the federal securities laws, then the SEC may take action against such investment adviser
In the Matter of Pegasus Investment Management, LLC, Peter Bortel, and Douglas Saksa (.pdf) (June 15, 2011) Pegasus VP Peter Bortel, under the supervision of President and CCO Douglas Saksa, allegedly did not disclose the arrangement to their fund investors and retained retained broker rebates for Pegasus, rather than passing it along to the investors. The SEC stated that Saksa failed to reasonably supervise Bortel within the meaning of Section 203(e)(6)
Direct Liability
CCO has direct liability for:
–Aiding and abetting, and causing firm violations such as:
•Responding to regulatory inquiries
•Responding to deficiency letters
•Adopt/implement policies and procedures
•Failing to file
– Permitting unregistered individuals to act
As an example the they cited In the Matter of the Buckingham Research Group, Inc., Buckingham Capital Management, Inc., and Lloyd R. Karp (.pdf) (November 17, 2010). The CCO allegedly represented in deficiency letter response that certain corrective action would occur (new policies/monitoring). The SEC claimed CCO was liable because he was responsible for establishing and administering the policies at issue and he “was aware of the compliance weaknesses and failures and either failed to act or failed to correct them”
Are you a supervisor?
Some factors are whether you have the ability to hire, fire, discipline, affect compensation. You would have the requisite degree of “responsibility, ability or authority” to “affect” the conduct of the employee whose behavior is at issue.
You can still be held liable as the SEC if you are overruled by superiors. (Scary!!)
In the Matter of Theodore W. Urban (.pdf), Adm. Proc. File No. 3-13655, Initial Decision (Sept. 8, 2010) Urban was General Counsel and headed Compliance, HR and Int. Audit. Urban had no authority to hire or fire employees outside of these departments, but he served on the board of directors and the firm’s credit and risk committee as a full voting member. SEC alleged that Urban was bad rep’s supervisor because of the role he played in monitoring bad rep’s actions. SEC also alleged that Urban failed to follow up on numerous red flags and took inadequate action regarding other red flags. As General Counsel, his opinions on legal/compliance matters were “viewed as authoritative and his recommendations were generally followed” by all business units.
The Administrative Law Judge found that Urban was a bad rep’s supervisor, but he had not failed to supervise because he performed his supervisory responsibilities “in a cautious, objective, thorough and reasonable manner”. The decision has been appealed to the SEC. So this ruling may change.
Combination/Separation of Legal and Compliance Functions
Some advantages to combining the roles:
- Federal Sentencing Guidelines call for adoption of a compliance program overseen by senior personnel
- Compliance is represented at senior management level
- GC is actively involved in strategic business decisions, offering exposure to potential compliance issues
- May be better positioned to push the firm toward appropriate actions/conclusions
- Direct or tangential experience with regulations
- “Noisy Withdrawal” trigger
- Reduced headcount
- GC is generally consulted on key compliance matters by senior management
Why separate the roles?
- Respects the differing goals of legal versus compliance (legal protects the firm; compliance prevents and detects violations
- Allows firms to acquire necessary skill set in each area
- Avoids misplaced privilege claims
- Creates necessary bandwidth to execute each role fully
- Allows each person to serve appropriate stakeholders
- Avoids conflicts at the board level/recusals
- Compliance gets same standing as legal in organization charts
Reporting
How about the CCO Reporting to GC?
- Centralizes legal and compliance in a single functional area. There is overlap.
- Matters identified can be more quickly resolved due to combination of functions
- GC may be in a good position to muster resources or provide a platform
- Gives clout to the compliance function. To the extent legal has clout.
How about an Independent CCO
- Highest degree of independence
- Decisions to report matters up to senior management or to regulators not subject to approval by GC
- CCO does not have to go outside reporting structure to raise matters to senior management
- GC does not need to create time to supervise the CCO
- Consistent with ICA 38a-1 and FINRA Rule 3130
As a case study, they used the Wunderlich case.
Avoiding Supervisory Responsibility
- Document with written supervisory policies and procedures
- Identify the direct supervisors of all employees
- Specifically state that compliance personnel are limited to offering advice and recommendations and do not have the responsibility, ability or authority to affect the conduct of employees outside of their departments
- Where misconduct is addressed, document which business-line supervisor is handling the issue and how
- Make it clear that the role on committees and boards is only advisory in nature