Compliance and Regulatory Services (“CARS”) Hot Topics for July 2015
For this distribution, we are highlighting an item that has been at the forefront of chief compliance officers’ (“CCO”) job related concerns, based on our clients’ feedback and questions being fielded by our staff: liability for serving as the CCO of an SEC-registered entity. The CCO’s nerve factor has risen recently due, in part, to the number of CCOs being cited and fined for compliance failures to the point that even Commissioner Daniel Gallagher felt compelled to express his concern in a press release dated June 18, 2015 (see link below). Gallagher cites two cases that he believes the CCO should not have been charged: Blackrock Advisors, LLC. (April 20, 2015) (“Blackrock”) and SFX Financial Advisory Management Enterprises, Inc. (June15, 2015) (“SFX”).
In the Blackrock case, Daniel Rice, an energy portfolio manager held a position in a family energy company (“Rice Energy”), which later formed a joint venture with a coal company that over time became the largest holding in a Blackrock Energy & Resources Portfolio to which Rice served as the manager. Blackrock compliance approved Daniel Rice’s investment and knew of the conflict of interest. Furthermore, Blackrock’s compliance program did not address outside business interests, which is one of the most fundamental policies and procedures a registered investment adviser must implement. The CCO failed to disclose the conflict of interest to the registered investment funds’ boards of directors. Blackrock and the CCO consented to the entry of an order finding that both violated, among other things, SEC Rules 206(4)-7 and 38a-1, the compliance program rules under the Investment Advisers and Investment Company Acts of 1940, respectively.
As for the SFX case, the president of the registered adviser was charged with violating his discretionary and fiduciary duty to his clients by stealing $670,000 over a 5-year period by writing checks to himself and personally initiating wires from client accounts for his own benefit. SFX’s compliance procedures called for the ongoing monitoring of client accounts by reviewing cash flows. The CCO did not oversee this activity and did not review client accounts, as required under the compliance program; therefore failing to exercise appropriate supervisory oversight of the president’s activities. The CCO was also responsible for misrepresenting in Form ADV, the firm’s SEC registration statement, that client accounts were reviewed several times a week. SFX and the CCO agreed to pay a $150,000 and $25,000 penalty, respectively.
The SEC’s actions against the two CCOs in both these cases could have been very easily avoided. After reading the facts, does it really appear as though the SEC is picking on these two CCOs? We think not. We keep coming full circle back to the same resolution regardless what the SEC infraction or rule violation cited. “We cannot stress enough the importance of maintaining rigorous compliance policies and procedures to address actual and potential conflicts of interest.” -The compliance program SEC rules cited are designed to be dynamic by requiring registrants to be constantly assessing operations, monitoring high risk activities and testing controls. This affords the CCO the opportunity to identify and address new and previously undetected conflicts of interest, which again is in keeping with the spirit of SEC compliance program rules.
(Complete Listing: http://www.finra.org/Industry/Regulation/Notices/2014/index.htm)
FINRA Rule Filings List
(Complete Listing: http://www.finra.org/Industry/Regulation/RuleFilings/2014/index.htm)