Developing a body of road-tested compliance practices remained the problem for fund families large and small as they met Tuesday's deadline to appoint chief compliance officers.
How the new executives will help companies comply with the stricter regulations spawned by the trading scandals remains in doubt because of the uncertainty surrounding what constitutes a compliance that will satisfy regulators.
Large fund families have the resources to handle compliance in-house, but some small ones are outsourcing the job.
In December the Securities and Exchange Commission adopted a rule requiring that all mutual fund companies appoint a chief compliance officer. Analysts said the rule, which enforces the Investment Company Act of 1940 and the Investment Advisors Act of 1940, also requires companies to adopt guidelines that lay out how they will comply with federal regulations.
The problem is, no one has said what these compliance officers are supposed to do, how they are supposed to do it, or what power they should have to get the job done, analysts said. Some banks' fund units have updated their compliance policies, and one is devising testing and validation procedures. Both Mellon and Wachovia have expanded their compliance staffs.
Analysts worry that the new watchdogs will lack the bite to protect themselves from regulatory scapegoating or their companies from more scandal.
"The law has created a position that is a potential target if things go wrong," said David J. Harris, a partner in the financial services group at the Dechert LLP law firm in Washington. "You have put a bull's-eye on the back of these compliance officers if there is ever a problem. Before, the responsibility was diffused. Now, it is concentrated."
There "are not new substantive requirements beyond that there be a compliance officer," Mr. Harris said. "Basically, you are putting someone on duty to watch without knowing what specifically they are looking for. They have created a scapegoat." This risk has made high salaries necessary to recruit able executives as compliance chiefs.
Glen Buggy, an associate at the executive search firm Christian & Timbers, said the issue of compliance has become the "big elephant in the room." Though fund families, including those run by banks, have hired chief compliance officers, everyone is waiting for the job to be tested, he said.
"People aren't as prepared as they think they are, and more so they aren't as prepared as they know they should be," he said.
It is not for lack of trying, Mr. Buggy said. The new rules are very nebulous, he said, basically just requiring compliance chiefs to certify that "everything is accurate" and in compliance with SEC regulations and standards.
"The spirit of these rules ha[s] always been there, but previously everyone thought the industry could govern itself," Mr. Buggy said. "Now, things are bigger and more complex. Regulations are needed, and these new officers are going to be accountable."
Mark Kuzma, the chief risk and compliance manager at Mellon Institutional Asset Management, said some companies will be ready to operate under the new regulations and others will not.
"If a firm is frozen and not acting, then they have something to worry about," he said. "If an organization takes the time to formalize the things they do and works actively to make sure the group is protecting itself and taking care of the requirements and meeting the guidelines, then they will be OK. You can never reduce the fear of regulations, but you can manage it."
Mr. Kuzma said most banks, keen on the notion of compliance, have had executives monitoring their fund units' operations for years. He has worked at Mellon since January 2001.
Jim Angelos, the chief compliance officer at Wachovia Corp.'s Evergreen Funds, agreed. He started at Evergreen in 1996 as director of compliance for mutual funds and last Wednesday was appointed chief compliance officer at a special board meeting.
He has spent the past 10 months cataloging the policies and procedures of the transfer agents, advisers, subadvisers, and subtransfer agents that work with Evergreen, Mr. Angelos said, in order to ensure regulatory compliance.
"I have been fortunate because at a firm the size of Evergreen when you need something for compliance you get it," Mr. Angelos said, "and that is critical. I can see at a smaller firm where you don't have these resources that they could feel that they don't have the tools to get the job done right."
Many smaller fund firms are turning to outsourcers to handle compliance. Bank of New York Co. has developed a Web-based product to help fund companies comply. The service, CCOaccess, gives chief compliance officers reports on post-trade compliance, market timing surveillance, and fair valuation.
Joe Keenan, a managing director and the head of product sales and marketing strategy at Bank of New York's global fund services unit, said small fund companies are not overwhelmed by the tightened regulations but some are not aware of the breadth of their new responsibilities.
"Fund companies don't want a third party to be their chief compliance officer; they just want us to provide ideas, controls, and procedures for them to follow," he said. "We have positioned ourselves as a resource for these chief compliance officers."
Executives at small fund companies say size does not matter when it comes to compliance.
"How prepared a firm is for these regulatory deadlines doesn't depend on their size but where compliance fits in their list of priorities," said W. Christopher Maxwell, the managing partner for compliance at Conestoga Capital Advisors in Radnor, Pa. "I talked to a relatively large firm that is a subsidiary of a bank that called us in a panic this past week because they hadn't put a lot of effort into dealing with compliance," he said last Friday.
Some large banking companies have hired people in recent months to meet Tuesday's deadline. The boards of Columbia Funds, Nations Funds, Galaxy Funds, and Liberty All-Star Funds, four Bank of America Corp. families, announced in mid-September that they had hired Mary Joan Hoene to be chief compliance officer. These families collectively had $221 billion of assets under management as of June 30.
Conestoga, which has $150 million of assets under management, manages just one portfolio, Conestoga Small Cap Fund, and Mr. Maxwell said he has been his firm's compliance officer since it opened in 2002 and became the chief compliance officer when the SEC created the title in December.
Mr. Maxwell said Conestoga has been working with Advisor Compliance Associates, a Washington, D.C., firm that helps small advisers deal with compliance, since early 2003.
Robert Stype, a managing partner at Advisor Compliance, said it has offered compliance services for three years and has developed a steady flow of business from both large and small companies. "Large firms have compliance officers in-house and are looking for guidance in specific areas while small firms may need help with the large picture to help get them moving," he said.
Analysts said the unanswered questions about the chief compliance post have left many qualified executives reluctant to take it on. DeChert's Mr. Harris said these executives have good reason to be nervous. A chief compliance officer who is fired has effectively ended his or her career in financial services, he said.
"They can't just go to another firm and start over again. If you strike out here, you have to go to another industry," he said. "This job is a real challenge. A person who considers taking it has to weigh the risk against the reward."
Large salary packages have been the result, according to most analysts. Mr. Harris said large fund companies are offering salaries as high as $500,000 for chief compliance officers. And Mr. Buggy, the recruiter, said he has seen compensation packages ranging from $500,000 to $1 million for top candidates.
"These individuals are taking a lot of risk," Mr. Buggy said; "they have to be well compensated to take on this position."
Analysts said this has drawn top candidates. Lawyers like Bank of America's Ms. Hoene have been attracted. But Brian Sullivan, the chief executive officer of Christian & Timbers, said by far most chief compliance officers are promoted deputy internal auditors.
The next step for compliance chiefs will be developing policies and procedures, and some have already begun.
Mr. Kuzma said that, when the SEC announced the regulations, Mellon took the opportunity to update its written policies and procedures. It also hired chief compliance managers at each of the smaller boutique investment managers it owns to oversee compliance there.
Culturally, Mellon is prepared for the enhanced scrutiny, Mr. Kuzma said.
"You don't see articles about Mellon having problems with compliance issues," he said. "That is because our investment management activities and compliance procedures have been very well received. We have the right culture, the right people, the right policies, and the right infrastructure."
In May, Evergreen Funds held a compliance meeting and decided to hire two additional chief compliance officers - for Evergreen Fund Distributors and Evergreen Fund Advisors. Mr. Angelos had handled all three units. He said Evergreen has increased the size of his staff by four, to 10 people, and the advisory compliance staff by four, to 10.
Mr. Angelos said he will now begin preparing testing and validation procedures for preparing the annual certification to the board that is required by the SEC. He expects to present the certification in March 2006, he said.
"When you are handling compliance for a firm, you are always in the bulls-eye. Now even more so," he said. "That is life as a chief compliance officer. That is part of the game."
