Rule 206(4)-7 under the Investment Advisers Act of 1940 (“Investment Advisers Act”) requires each investment adviser registered with the U.S. Securities and Exchange Commission (“SEC”) to designate a chief compliance officer (“CCO”) to administer its compliance policies and procedures. There are no specific exam, continuing education, or industry experience requirements outlined under Rule 206(4)-7 for an SEC registered investment adviser’s CCO. However, the SEC’s final rule release for Rule 206(4)-7 states, “An [investment] adviser’s chief compliance officer should be competent and knowledgeable regarding the [Investment] Advisers Act and should be empowered with full responsibility and authority to develop and enforce appropriate policies and procedures for the firm. Thus, the compliance officer should have a position of sufficient seniority and authority within the organization to compel others to adhere to the compliance policies and procedures.”
Investment advisers are not required to hire an individual to act solely in the capacity as the CCO. In many cases, the CCO will also have other responsibilities or have other roles within the investment adviser. What is extremely important for any investment adviser is that the individual appointed by the investment adviser to serve as the CCO is someone that is truly qualified and has the appropriate amount of time to dedicate to the role as CCO. An investment adviser may have an individual on staff that performs many of the compliance functions for the investment adviser but that individual may not be truly qualified to serve as the CCO. Having an understanding of the various compliance responsibilities for the investment adviser is not qualification enough to appoint the individual as the CCO. The CCO can delegate the various investment adviser compliance functions to other individuals, but the CCO needs to be someone that cannot only think in terms of whether what is being done is done right but also in terms of what additional policies, procedures, and internal controls need to be developed to strengthen the investment adviser’s culture of compliance. When considering who should be appointed or hired as the CCO, the following are some of the questions that should be considered:
- What is the individual’s background and experience as it relates to investment advisory compliance?
- What is the individual’s knowledge and understanding of the Investment Advisers Act?
- How much time will the individual have to dedicate to the role as the Chief Compliance Officer?
- Is the individual in a position of sufficient seniority and authority within the firm to compel others to adhere to the compliance policies and procedures? In other words, can this individual establish policies and procedures when necessary without push-back or someone being able to override the individual’s decisions as to what policies and procedures are needed within the investment adviser firm? When the situation warrants, does this individual have the authority to determine corrective or disciplinary actions that can be taken against any supervised person of the investment adviser, including those in upper management positions?
The CCO’s knowledge and amount of time spent performing the required duties for the investment adviser are factors that will be considered by the examiner during a regulatory exam. Having a CCO that does not have adequate experience, knowledge, and time to dedicate to the role as the CCO for the investment adviser can result in exam deficiencies, enforcement actions, and penalties and fines for the investment adviser. If the securities regulator does not believe that a CCO has adequate time to devote to the duties involved in serving as the investment adviser’s CCO or adequate knowledge of the Investment Advisers Act, it may simply be something noted in an exam deficiency letter for further investigation. The investment adviser may receive a deficiency notice containing language similar to the following:
Examiners are concerned that, among other things, the Registrant’s CCO may not be adequately trained with respect to the advisory regulations and sufficiently familiar with investment adviser’s operations in order to identify or address conflicts of interest that are present at the investment adviser. During the examination, examiners recommended that the CCO seek additional training on compliance issues and the laws and regulations as they relate to the advisory activities of the Registrant. Examiners also pointed out that although the CCO oversees the compliance procedures, investment adviser’s personnel should be cognizant of the Registrant’s compliance requirements.
During the examination it did not appear that the CCO was sufficiently familiar with the Investment Advisers Act. Thus, it is not clear that the investment advisory representatives are adequately or appropriately supervised regarding their advisory activities. It was represented that the CCO is currently serving as the compliance officer for the investment adviser as well as the broker-dealer in addition to his duties as chief financial officer. It is possible that the CCO may have too many responsibilities, in addition to his duties as CCO, to ensure adequate oversight. In response to this letter, please provide an explanation detailing the investment adviser’s basis for believing that its CCO meets the requisite elements of competence and knowledge regarding the Investment Advisers Act, as noted in Release No. IA-2204.
Another possibility is an investment adviser could face an enforcement action related to the CCO. For example, an administrative action was issued by the SEC to a firm that had one individual serving as the CCO for the broker-dealer and the investment adviser. Among other things, the firm was cited for deficiencies related to the amount of time that was dedicated to broker-dealer compliance vs. investment advisory compliance. In the administrative order, the SEC indicated that the respondent’s “…compliance breakdown was caused by its failure to invest necessary resources in the firm’s advisory business as it changed and grew in relation to its brokerage business.” The order went on to discuss the volume of advisory business versus brokerage business and the limited amount of time spent on compliance related issues for the advisory business (“…less than 5%…”) versus the amount of time spent on compliance related issues for the brokerage business (“…about 95%..”). This is probably a good example of a situation where the CCO did not have enough time or resources to dedicate to his role as the CCO for the investment advisory side of the business.
The severity of the actions the securities regulator will take will likely be determined based on the number and severity of the violations found during a regulatory examination of an investment adviser and not simply on the CCO’s knowledge level and ability to dedicate enough time to investment advisory compliance. However, the CCO’s lack of knowledge or lack of appropriate time performing duties related to the role as the CCO for the investment adviser will be consider to have a direct impact on the fact that the violations exist in the first place. Investment advisers need to examine very closely whether they have adequate resources dedicated to compliance and whether they have the right person serving in the role as the CCO.
To learn more about the role of Chief Compliance Officer for an investment adviser, register to attend our webinar, “Understanding the Role of the Chief Compliance Officer (CCO).” RIA Compliance Consultants will host this webinar on February 21, 2013 at 12:00 p.m. CST. To register for this even, click here.