Dear regulator

The challenge: 

Fund managers often need to respond to regulatory inquiries, including questions and answers during an exam, responses to deficiency letters, informal requests for information and, of course, subpoenas. Too often, a manager’s ill-conceived response to these inquiries leads to further regulatory investigation that could have been avoided. In the worst case, a firm’s poor response to a preliminary request for information can lead to enforcement action. So the challenge is: what’s the best way for GPs to answer a regulatory inquiry?

Harry Frischer’s response:

Few people set out to answer a regulator’s question incorrectly.  But errors can creep into responses in a variety of ways, with the potential for unpleasant consequences.

In one instance, for example, a regulator requested information about trades in certain swaps during a particular period.  The adviser had records of both the “trade date” for the transactions, i.e. the date on which the parties agreed to the terms, and the “effective date” that the parties had agreed to.  With regard to the swaps in question, there were a number of trades made during the relevant window, but the effective date for each trade was outside that period. In developing the fund’s response, a junior employee reviewed only the effective dates and concluded, erroneously, that there were no trades during the period under review. Fortunately, this error was caught before a response was sent to the regulator.

One must also be clear in their responses. If not, the reader may reach an understanding very different than the meaning the writer intended to convey, a result to be avoided when communicating with a regulator. A response that includes vague, jargon-filled abstractions may read like gibberish to a regulator.

Another best practice is responding to a regulator promptly.  For an email request, for example, a service provider responsible for restoring the material may take longer than expected or pull the wrong set of emails.  The person who needs to review the emails may be on vacation. The person who can answer substantive questions about them may be on maternity leave.  Murphy’s Law ensures all these factors will come into play at the same time.

Also be sure to provide complete answers. When a regulator asks five questions, she expects five answers. Surprisingly, firms sometimes overlook portions of the inquiry, leaving the impression that they are evading the questions.

Responses should also be careful to not come across argumentative. The art is to be persuasive by providing a response that reads like a neutral presentation of the facts. Repeated references to the firm’s “culture of compliance,” for example, may sound defensive and irrelevant, unless backed up with actual facts and tailored to the specific inquiry.

These problems can be avoided by a rigorous fact-checking process, a second-level review of written communications with regulators to ensure that they complete, clear, and supported by the facts, and increased training of personnel dealing with the regulator or developing information for regulatory responses. Firms should request in writing that the regulator clarify ambiguous or unclear terms so that the response is mutually understood. Terms or phrases used in the response which are specific to the firm, or not commonly understood, should be clearly defined. The firm should record the specific responsibilities of personnel assigned to formulate different components of the response and stress the importance of answering regulatory inquiries promptly and accurately. Anticipated delays usually should be discussed with the regulator in advance and memorialized in writing.