In our last edition, we discussed a statement by outgoing (but still fully functioning) SEC Commissioner Daniel Gallagher regarding recent SEC actions that included charging Chief Compliance Officers with regulatory violations. In one case, an investment adviser’s CCO was charged with causing the firm’s violations, based on an alleged failure to ensure that the firm had sufficient compliance policies and procedures. In another matter, a CCO was charged with failing to implement compliance policies and procedures that would have detected an alleged theft of client assets by the firm’s president.
According to Commissioner Gallagher, “[a]ctions like these are undoubtedly sending a troubling message that CCOs should not take ownership of their firm’s compliance policies and procedures, lest they be held accountable for conduct that … is the responsibility of the adviser itself. Or worse, that CCOs should opt for less comprehensive policies and procedures with fewer specified compliance duties and responsibilities to avoid liability when the government plays Monday morning quarterback.”
It appears Commissioner Gallagher may have touched a nerve and, more importantly, alerted the Commission to the significant potential side-effects that can result from making CCOs responsible for the actions of the firms that they are charged with policing. Last week, Commissioner Luis A. Aguilar issued a public statement, The Role of Chief Compliance Officers Must be Supported. In his statement, Commissioner Aguilar acknowledged the “important and crucial role” that CCOs play “in fostering integrity in the securities industry.” He explained that CCOs have responsibility for “making sure that their firms comply with the rules that apply to their operations,” “to instill a culture of compliance, nurture an environment where employees understand the value of honesty and integrity, and encourage everyone to take compliance issues seriously” and to “work to prevent violations from occurring in the first place and, thus, prevent violations from causing harm to the firm, its investors, and market participants.” He declared that, “[s]imply stated, the Commission needs capable and honest CCOs to help protect investors and the integrity of the capital markets.”
Explaining that he himself is a former head of compliance, Commissioner Aguilar took pains to convince CCOs who put investors first and do their jobs competently, diligently and in good faith, that they need not worry about being targeted by an SEC enforcement action. His goal was to assure the compliance community that, despite Commissioner Gallagher’s strongly worded statement, the Commission is not looking to bring enforcement actions against CCOs who take their jobs seriously and do them competently, diligently and in good faith to protect investors. He pointed out that there have been “relatively few” actions brought against CCOs; for example, over the past six years, the number of enforcement cases brought annually against CCOs of investment advisers and investment companies by the SEC has never exceeded 19 percent of the total actions brought against such firms and, in most years, has run between 6 and 11 percent.
Whether or not the number of actions referenced by Commissioner Aguilar can be viewed fairly as “relatively few” (in real numbers, it runs between 7 cases in 2010 and 27 in 2013) is, of course, in the eye of the beholder. The CCO and compliance community in general might disagree that this represents relatively few actions. Perhaps a more important and potentially comforting observation by Commissioner Aguilar is that most of the referenced cases “involved CCOs who ‘wore more than one hat,’ and many of their activities went outside the traditional work of CCOs, such as CCOs that were also founders, sole owners, chief executive officers, chief financial officers, general counsels, chief investment officers, company presidents, partners, directors, majority owners, minority owners, and portfolio managers.” The Commissioner also noted that many cases also involved compliance officers “who affirmatively participated in the misconduct, misled regulators, or failed entirely to carry out their compliance responsibilities.”
It certainly goes without saying that compliance officers who are actively complicit in wrongdoing should be charged, irrespective of their title or role. And if it is shown that, despite being paid for the responsibility of developing, overseeing and maintaining a firm’s compliance program, a CCO does nothing other than what is necessary to give the appearance of performing his or her role, and does not establish or at least recommend the establishment of an appropriately tailored compliance program and systems to address the regulatory risks and requirements of the firm’s business, then there is likely room for finding regulatory violations. Nevertheless, at the risk of belaboring what should be obvious, the SEC must be extremely careful not to send the wrong message to CCOs and the rest of the compliance community, or it will risk weakening the efforts of what is, in the words of Commissioner Gallagher, “not only the first line of defense, [but] the only line of defense.”
If nothing else, the Commissioners’ dialogue on the subject provides a valuable wake-up call to the compliance community that its role is critical and that vigilance is important, and to financial firms generally that they must hire quality people for and dedicate sufficient resources to the compliance function. However, despite Commissioner Aguilar’s assurances, increasing the number of enforcement actions against CCOs may have some unintended, and potentially tragic, consequences. Persons contemplating serving as compliance officers may feel that the risk of liability outweighs the remunerative, professional or psychic rewards. This could result in a paucity of competent compliance professionals. It also could become prohibitively expensive for all but the largest of firms to afford the increasing cost of competent compliance personnel. Although it is possible that Commissioner Aguilar’s comments will cause investment adviser executives to re-think whether it is prudent to perform multiple, potentially divergent roles within their firms, it also may reduce the number of small or independent firms, many of which simply cannot afford multiple professionals to perform separate and distinct functions. When a butterfly flaps its wings in Asia, it may take some time to see whether, and to what extent, that has an impact in North America. How long might it take to see the impact of this dialogue by the current Commissioners? We can only wait and see.