A few weeks ago we reported on BlackRock’s failure to disclose a conflict of interest involving the outside business activity of one of its key portfolio managers, Daniel Rice III. In the time since, we’ve asked compliance officers and consultants how a multitrillion asset manager like BlackRock, with all its resources, could have suffered a compliance failure of this magnitude. The case highlights a number of areas where BlackRock’s processes appear to have lacked robustness. For other managers, there are a number of learnings from the case worth heeding:
Failure to disclose: It seems that even with sufficient disclosure, it would have been impossible to justify Rice’s family owning and running an oil and gas company that, over a period of time, would become one of the biggest holdings in a BlackRock energy fund he managed simultaneously. But according to SEC documents, the dealings weren’t being disclosed to investors or the appropriate fund boards at all. BlackRock’s compliance and legal team eventually looked into the matter and approved the dealings subject to certain conditions, but what they seem to have failed to remember is that it is the investors, not the manager, who are entitled to determine whether or not a potential conflict of interest is acceptable.
Failure to monitor: Another alleged mistake was not to review Rice’s interest in Rice Energy as it grew in value over time. Approving an investment on the basis that it doesn’t constitute a material conflict might be the right thing to do initially, but this may change as the investment becomes more valuable. According to industry sources, partners in a private fund management firms often opt to not disclose personal investments because they consider them too irrelevant or insignificant to report; this may, be appropriate at first, but could become a problem if the investments in question aren’t reassessed on a regular basis.
Failure to confront: At BlackRock, Daniel Rice was the benchmark-beating super-stud energy partner hired in 2005 to strike lucrative deals. Bartholomew Battista was the compliance officer signing off on his dealings. Compliance consultants tell us it can be difficult for compliance professionals to confront influential dealmakers, especially so when they’re hauling in millions of profit for the firm. In the end, Battista became the sole BlackRock executive to pay a civil fine ($60,000) for the firm’s role in the Rice case, which compliance officers should take as a warning about their liability dangers in cases such as these, and the need to confront their colleagues as and when necessary and with sufficient rigor. It may not be sufficient for CCOs to ask the deal partners to submit certifications or answer questionnaires about their outside business interests. To determine whether or not any conflicts exist, a better approach might be to interview them, or members of their families, face to face.
Failure to communicate: From time to time, Rice allegedly discussed his Rice Energy business interests with other BlackRock senior executives. Those involved in these conversations should have raised alarm bells, rather than leaving it to the CCO to provide the only line of defense. There needs to be firm-wide understanding that compliance risks must be reported.
In our May issue, available now, pfm subscribers received a special report on compliance that explores strategies to stay in regulators’ and investors’ good graces. One of them is the duty to keep an up-to-date compliance manual, which in light of the BlackRock case many CCOs are no doubt reviewing.