Human capital factor

John Schneider of KPMG and Daniel Bender of Navigant Consulting discuss how to maximise spending efficiency and benchmarking compliance programmes.

The recent more aggressive Securities and Exchange Commission (SEC) enforcement action of and the SEC’s adoptions of rules for more formal compliance programs for investment advisers has had a profound effect on the role of compliance within investment management organizations. Namely, the formerly quiet roles of the chief financial officer, chief compliance officer and chief risk officer have been elevated from the background to the front lines of firms’ efforts to effectively manage business risk. This has resulted in the individuals with these roles and responsibilities having a seat at the executive table and possessing a newfound influence in the firm’s decision-making process.

The Investment Advisers Act of 1940 (the ‘Advisers Act’) require that an adviser ‘implement written policies and procedures reasonably designed to prevent violation’ and the federal sentencing guidelines requires that federal prosecutors and federal judges take into account a corporation’s compliance program in determining whether to charge and to sentence a corporation in the event of an alleged wrongdoing. As private equity firms consider the human capital requirements and the costs associated with implementing and maintaining a compliance program, they should understand the expectations and the watermark that has been established by regulators for the financial services industry in the adoption of compliance programs.

The SEC’s role in policing the activities of the private fund community has been increased with the Dodd-Frank Wall Street Reform and Consumer Protection Act requirements.

Signed into law in July 2010, the Act calls for an increased number of advisers to register with the SEC and thus be subjected to government oversight. In turn the SEC will develop additional systemic reports to be furnished to the Commission. In addition, within the SEC, the Division of Enforcement and the Office of Compliance Inspections and Examinations (OCIE) have also been much more aggressive in their expectations from advisers for their compliance program. A review of the focus areas in an OCIE examination will help the adviser determine the design and resulting cost of its compliance program.

This chapter will provide a perspective on the SEC requirements for compliance programs in an effort to establish a standard and provide an overview of the costs, metrics and benchmarking, and strategies for designing a compliance program. Of course there is no one-size-fits-all approach to developing, implementing and maintaining a compliance program. In fact, regulatory expectations are quite the contrary; regulators expect that compliance and risk management programs be designed, supervised and monitored in such a way as to address the risks specific to a firm’s business activities as well as client or product profiles.

Compliance program development

‘What’, ‘where’ and ‘to whom’ impacts greatly the compliance staffing model. On a pragmatic level, knowing who to contact if a potential issue or question arises often becomes a significant challenge. Developing a model that is tailored to each organization is critical, but some elements that should be considered for all organizations include product complexity, distribution and regulatory oversight. For example, a single fund private equity firm, operating in a single jurisdiction, with few investors may only need one to two compliance staff, while a firm with multiple funds, operating in multiple jurisdictions (and presumably under the supervision of multiple regulators) with a wide range of distribution partners (that is, solicitations firms) and diverse investor base (municipalities, foreign governments and ERISA plans), may require more compliance officers.

An adviser should have a road map to manage its compliance program development, implementation and evolution as part of its consideration for the human capital required and the costs associated. The following steps should be part of the consideration when evaluating the program and the associated costs:

• Establish a vision;
• Organize the compliance structure;
• Define compliance requirements;
• Map compliance requirements to business activities;
• Prioritize compliance requirements using a risk-based approach;
• Draft, review and adopt policies and procedures;
• Launch and implement compliance program monitoring and testing; and
• Review of the program.

This partial chapter is one of 24 in The US Private Equity Fund Compliance Guide: How to register and maintain an active and effective compliance program under the Investment Advisers Act of 1940, a new book from PEI Media.