Debra M. Brown
April 17, 2003
Jonathon G. Katz, Secretary
Re: Comments Submitted on Proposed Rule: Compliance Programs of Investment Companies and Investment Advisers (File No. S7-03-03)
Dear Ladies and Gentlemen:
Thank you for the opportunity to comment on Proposed Rules 38a-1 under the Investment Company Act of 1940, as amended, Rule 206(4)-7 and Rule 204-2 under the Investment Advisers Act. Brown & Associates and Self Audit, Inc. provide specialized compliance related services to mutual fund companies and investment advisers of the nature described in the proposed rules. Financial services companies engage our firm to conduct "mock" regulatory reviews and to make recommendations on their regulatory compliance programs. We have also served as "independent consultant" to firms that have experienced regulatory problems and created compliance programs for investment advisers and investment companies. Self Audit, Inc. is a provider of software that enables firms to conduct mock audits internally. Both firms provide clients with a means to incorporate proactive compliance procedures into their organizations. In this context, we submit comments on the proposed rulemaking requiring all registered investment companies and registered investment advisers to have compliance policies and procedures, review the procedures annually and designate a compliance officer for each entity.
Mandatory Compliance Policies and Procedures
Our firm supports the requirement that investment advisers and investment companies have compliance policies and procedures. Although the vast majority of firms already have compliance policies and procedures, the mandatory requirement may elevate the importance of these policies and procedures. Several years ago during a presentation of our software to some Securities and Exchange Commission ("SEC") inspection staff members, a staff member asked "How do you get firms to use the "self auditor" tools after purchasing the tool?" For the last two years our firm has been dedicated to finding an answer to that question rather than just selling the self auditor program. Our research told us that the two most effective ways to encourage firms' to conduct mock audits of their policies and procedures is by educating them on the consequences of flawed programs and by having a firm's Chief Executive Officer or Chief Operating Officer support an independent review. This finding is consistent with the SEC's findings that the "tone at the top" is an important if not most important element of a good compliance program.1 Although many compliance officers initiate independent reviews, approval for these reviews ultimately rests with the firms' CEO or COO. We also believe that when the SEC sets forth examples of good practices, it is easier for firms to implement appropriate procedures. Recent SEC speeches have incorporated "best practices" recommendations. We believe that this information furthers the ability of firms' to implement best practices.2 Through education and keeping the responsibility for compliance at the highest levels of senior management, firms will make progress in their compliance programs.
In our experience of reviewing firms' compliance programs, deficiencies generally do not result in or indicate fraudulent practices. Rather, it has been our experience that deficiencies result when the regulations are not clear or the firm is not aware of a certain requirement. Although tighter compliance programs may prevent rogue activity by an employee, less formal compliance programs do not necessarily result in fraud. It is for this reason that we believe that the failure to have adequate policies and procedures should not come under the anti-fraud provisions of the Advisers Act. Failure to have adequate procedures should remain as a books and records matter, not a matter of fraudulent, deceptive or manipulative acts, practices or course of business.
Designation of a Compliance Officer
In our experience when the "tone at the top" is supportive and proactive for a good compliance program, the opposite is also true. When the "tone at the top" is not supportive of a good compliance program there is no compliance officer (no matter the credentials) or independent consultant that can implement an effective compliance program. Although we can try to put policies and procedures in place, if a firm fails to follow those procedures and policies, the overall program will not be effective. This has happened even in cases where firms' are required to hire an independent consultant. If the firm is not committed to turning around the compliance program, it is unlikely that an effective compliance program will be implemented.
The rule proposal requirement for investment advisers and investment companies to designate a compliance officer would weaken the requirement that each firm have a compliance program. By designating a compliance officer, firms will delegate the responsibility for compliance to that compliance officer. There will be little incentive for experienced, well-qualified compliance officers to take on new positions in the industry that could likely result in their own personal liability. In fact, this element of the rule proposal if adopted, would discourage individuals from seeking the compliance officer role because of liability concerns.
At many firms the compliance officer is not a member of senior management and have little or no input into the management of the firm. When firms have not implemented an effective program, it is usually because compliance has not been a top management priority. For several years the SEC's Office of Compliance Inspections and Examinations focused their examinations on each firm's compliance officer and compliance department.3 Lately, the SEC staff appears to be more appropriately focused on the top management team of the company.4 Therefore we recommend that the staff remove the requirement for the designation of a compliance officer.
In addition to the general comments above, the following specific comments are submitted:
These regulations have the potential of improving many firms' compliance programs and elevating the importance of the compliance to the senior management in many organizations. Please do not hesitate to call me at (978) 921.6688 with any questions.