Time for chief compliance officers to get tough and get smart, or else

As you might expect from someone my age, I am a big fan of the long-running television drama “NCIS,” in which a hard-bitten former Marine, Leroy Jethro Gibbs, solves crimes with his crack team of investigators.

The signature moment of the show is Gibbs’ infamous head slap delivered to his second in command, Special Agent DiNozzo, to warn him that he’s about to do something stupid or has already committed a blunder.

Chief compliance officers (CCOs) should be the Special Agent Gibbs at investment advisory firms. Just as Gibbs has dozens of rules that must be obeyed, a CCO should establish the firm’s compliance rules in its policies and procedures and make certain they are followed.

Although I’m not advocating that CCOs give a head slap to supervised persons who make compliance mistakes, these officers do need to rigorously exert their authority. The CCO for a registered investment adviser should not be a shrinking violet. CCOs should be in a position of sufficient authority and seniority to compel others to comply with the RIA’s policies and procedures.

Lack of knowledge is a dangerous thing

CCOs should be extremely knowledgeable regarding the Investment Advisers Act of 1940 and the rules that implement the statute. I have read several deficiency letters that criticized an RIA’s CCO for lacking knowledge regarding their compliance responsibilities. One letter criticized a CCO for not being familiar enough with the Investment Advisers Act to ensure compliance with the law.

In another deficiency letter, the SEC’s examination team observed that the CCO did not appear to be fully engaged with compliance matters. While some of a CCO’s duties may be delegated to a designated person, too much delegation can cause problems. The CCO was chastised for allowing a designee to do all of the work on the firm’s policies and procedures. As a result, the CCO was unable to respond to any of the examiners’ questions about the firm’s compliance program.

Head slaps for two RIAs

In May of this year, the Securities and Exchange Commission administered metaphorical head slaps to a pair of firms that failed to fulfill their compliance obligations — demonstrating that the SEC is prepared to deal harshly with CCOs who do not fulfill their responsibilities.

On May 27, the SEC announced settlements with a Memphis-based RIA/broker-dealer, as well as its CCO and CEO, for violating the Investment Advisers Act and several rules. The firm’s CCO was ordered to pay a civil money penalty of $50,000. In addition, the firm was required to pay a civil penalty of $125,000. The SEC also ordered the dually registered firm’s CEO to pay $45,000.

Among other violations, the firm failed to implement effective policies and procedures and did not conduct an annual review. The firm also failed to comply with the Code of Ethics Rule. In addition, the firm knowingly effected thousands of securities transactions for advisory clients while acting as a principal for its own account. The firm was required to disclose to these clients in writing before the completion of each transaction that the firm was acting as a principal. The firm and its CCO failed to satisfy the disclosure and consent requirements mandated by Section 206(3) of the Investment Advisers Act. The firm also overcharged numerous advisory clients for commissions and other transactional fees in thousands of separate transactions.

On May 9, the SEC sanctioned a Santa Monica RIA and its principals, one of whom was the firm’s CCO. Among other sanctions imposed, the RIA was ordered to pay a civil money penalty of $200,000. In addition, the CCO was required to pay $100,000. A second principal was also ordered to pay $100,000.

The RIA and the CCO were cited by the SEC for failing to implement written procedures designed to prevent violations of the Investment Advisers Act. In accordance with those policies and procedures, the firm’s CCO was required to review the responses to Requests for Proposals for misleading statements about the RIA’s prior SEC examination. The CCO willfully violated those procedures and Section 206(2) of the Investment Advisers Act, which makes it unlawful for an RIA to engage in any transaction, practice or course of business that operates as a fraud or deceit upon any client.

The SEC also charged the RIA and its principals with failing to make and/or retain copies of employees’ acknowledgments that they had received the firm’s code of ethics. The RIA received deficiency letters in 2005 and 2008 notifying the firm of that requirement.

Gibbs’ rules for CCOs

The lesson for CCOs to learn from these sanctions is that they are putting their necks on the line if they don’t know their job and fulfill their responsibilities. CCOs should not assume that supervised persons are complying with policies and procedures, even if they are assured that this is the case. CCOs need to follow Gibbs’ Rule #3: Don’t believe what you’re told. Double check.

And finally, remember that policies and procedures can always be improved as a result of your annual review. Even if your firm has not had compliance problems in the past, policies and procedures can always be tweaked to ensure that they are thorough and effective. It’s akin to Gibbs’ Rule #8: Never take anything for granted.

Les Abromovitz is a senior consultant with National Compliance Services, Inc. Les, an attorney, is the author of Growing Within the Lines: The Investment Adviser’s Advertising and Marketing Compliance Guide (Available on Amazon.com or through NationalUnderwriterStore.com). He can be reached at 561-330-7645, Ext. 213, or at LAbromovitz@ncsonline.com.