The Investment Company Institute's guidance last week to help fund companies comply with annual-review regulations has prompted a harsh response from a lawyer who represents fund companies and says the guidelines offer little substance.
"I was a little surprised there is not as much there as I thought there was going to be," said Margaret Sheehan, a lawyer who has five fund company clients and is co-leader of the financial services practice at Alston & Bird, a Washington law firm. It could be helpful, though, to a small fund family "that isn't very sophisticated," she said.
The institute, a Washington trade group for the fund industry, developed the guidelines to help chief compliance officers meet reporting requirements established by the Securities and Exchange Commission in the wake of the fund-trading scandals.
Elizabeth Krentzman, the institute's general counsel, said its paper offers tools for compliance officers to use. Fund companies must complete an initial annual review by April and report to their boards no later than June. The requirements were adopted to improve oversight after many fund companies had to settle charges of inadequately supervising funds in which trading abuses took place.
"We certainly hope this helps chief compliance officers," Ms. Krentzman said. "It is the first time in one place that we have compiled various menus and tools for chief compliance officers."
Carl Frischling, the co-head of the financial services group and a senior partner at Kramer Levin Naftalis & Frankel, a New York law firm, said chief compliance officers have welcomed the institute's guidance. He has fund boards of directors as clients.
Ms. Sheehan, however, said the institute has missed an opportunity to supply useful guidance.
"A lot of this is stuff that any compliance officer should know already," she said. "Most compliance officers with whom I work are familiar with different testing options. … My sense of this thing is that it looks good, but I just don't know how much it really offers a chief compliance officer at a large fund complex. I don't know how much it really offers anyone other than a really small fund complex that isn't very sophisticated."
She added, "It is a solid report, but I don't see anything in here that is particularly provocative or insightful." Among compliance issues she sees looming is the question of e-mail content and retention. "Compliance officers will be expected to monitor" e-mail, she said, "and retain it."
Among other topics, the paper outlines a process for planning annual reviews; the options for doing compliance testing, including interviews of key people; observations of daily operations, data testing, and trend analysis; a process for preparing annual reports to fund boards; and related record keeping.
Ms. Sheehan said she "kept looking for the juice" when she read the paper but found none. She said she had hoped that the institute would create a unique tool, template, or software that compliance officers could use. But the institute's paper was "pretty straightforward stuff."
James Doyle, a spokesman at the institute, said even if the information is not necessarily new the guidelines bring together a menu of options compliance officers would find useful.
"We put this together at the request and [with] the involvement of chief compliance officers through our committee," he said. "Everything we have heard so far indicates that this is a useful tool. Even people at the SEC have given it positive feedback." Five banking companies contacted for this report declined to arrange interviews with their chief compliance officers.
Mr. Doyle said the institute would update and improve the report as needed.
Ms. Sheehan said she knows that with compliance it is impossible to create a "one-size-fits-all" framework but that the institute should work to create "a modular matrix or a software tool that people could design from."
Mr. Frischling said many compliance officers are concerned about how they are doing and have welcomed the institute's guidelines.
"These guidelines offer compliance officers the guidance they have been looking for in terms of how to handle reviews and testing and the educational process," he said. "There was and still is a discomfort, especially for smaller organizations, in terms of how to handle compliance."
The SEC purposely gave very little guidance on what was expected from compliance officers, Mr. Frischling said, so that the industry would establish the guidelines. The institute's guidelines try to put compliance officers at ease, he said.
"Everyone is still waiting for the next shoe to drop and the next problem to occur," he said. "No one is at ease. There will always be problems; compliance officers want to know that they are all on the same page."
Ms. Sheehan said the next substantive regulatory issue that compliance officers could face may concern e-mail communications. The SEC could begin to examine what portfolio managers say in e-mails, she said, and fund companies could be subjected to regulatory scrutiny because of this.
"People don't treat e-mail the way they do a more formal written communication," she said. "E-mail isn't a phone. It is a permanent record. If there is anything that has changed and will continue to change, it is the way the SEC treats e-mails."
Fund companies will have to carefully train portfolio managers about what they can say in e-mails, she said. "Everyone needs to imagine that their e-mail is going to be on the front page of The New York Times. They cannot allow a personal bad day [to] become part of the public record that gets their company in a whole lot of trouble."
Ms. Sheehan said that, whether the issue is annual review or e-mail, no one, including the institute, can create a set of recommendations that will put compliance officers at ease.
"Nothing in here says here is what you have to do to be free of any legal liability," she said. "This is a bunch of ideas, and they are good ideas, but it is not as practical as it could be or as deep or as useful as it could be. I am not sure that it will work from a liability protection standpoint."
