August 17, 2003
These comments by Shawbrook are in response to the "Commission's proposed rule: Compliance Programs of Investment Companies and Investment Advisers" (File No. S7-03-03). Shawbrook is a registered investment advisor based in Alexandria, VA.
"We request comment on our proposed requirement that advisers and funds adopt compliance policies and procedures."
The Commission's rationale for intensified regulatory oversight of investment advisors seems to be that "Our experience is that funds and advisers with effective internal compliance programs administered by competent compliance personnel are much less likely to violate the federal securities laws." That may be true as a matter of correlation, but is hardly a matter of causation.
It is not surprising that advisors who intentionally violate securities rules and laws also do not have "effective internal compliance programs." First of all it is a self-evident proposition; an "effective compliance program" would, by definition, not allow systematic intentional fraud. Secondly it would not make any sense for advisors who intended to defraud their clients to have established "effective internal compliance programs" administered by "competent compliance personnel."
Nonetheless it might be worth asking, as perhaps the Commission is asking, would a mandatory "compliance program" deter an advisor determined to commit securities law violations. Were the executives of companies such as Tyco, Enron, Worldcom or Rite-aid stopped from committing alleged violations by the fact that their firms were audited by certified public accountants? Were the broker-dealers who kept the spread on NASDAQ quotes at eighths instead of sixteenths for years deterred by their industry's SRO? History and commons sense show that people who would risk violating fundamental laws think nothing about also violating rules governing the administration of those laws. One could similarly see that anyone who was willing to commit tax fraud would not be deterred if the IRS were to require them to establish a "chief tax compliance program."
"We request comment on the costs and benefits of the Proposed Rules."
Although the Commission has not documented any broad problems in the RIA profession it has provided at least some examples, cited in footnote 14, of the results of what it claims are the "consequences of inadequate compliance programs." Those examples contain the following violations:
"improper cross trades, principal transactions, and personal trading"
"purchase and pricing of private placement securities"
"misappropriated funds' investment opportunity on behalf of private profit-sharing plan he also managed"
I will state the obvious: that all the cited problems are directly related to trading. It is curious that the Commission does not focus on this one area, but instead reaches for broad remedies such as SRO's and annual compliance reviews. Just off of the top of my head I can think of two remedies more appropriately targeted at trading:
1) Expand that portion of the Series 65 exam dealing with trading, even lengthening the overall exam if necessary.
2) Working with investment advisors and the institutional brokerage firms [e.g., Schwab, Fidelity and T.D. Waterhouse] that custody RIA assets, develop a computer system that would, in a more comprehensive yet time and labor saving manner, allow the commission to identify potential trading problems. I believe some custodians, such as Bear Stearns, already use computers to monitor the trading of some of the hedge funds they custody.
Should we require that the chief compliance officer be a member of senior management of the fund or the adviser?
One of the Commission's proposed remedies is appointing a chief compliance officer who is supposed to be "competent and knowledgeable regarding the applicable federal securities laws and should be empowered with full responsibility and authority to develop and enforce appropriate policies and procedures". I would only note that investment advisors are already supposed to be "competent and knowledgeable regarding the applicable federal securities laws."
"We request comment on whether one or more SROs should be established for funds and/or investment advisers. Should the SROs be limited in their authority? For example, should they be limited to conducting examinations? How should the activities of an SRO be financed?"
If the problems of investment advisors are really so widespread and endemic to the profession that the Commission is seriously contemplating establishing an SRO then I would suggest such problems should be given the respect they deserve. That means to begin with the Commission should either sponsor or conduct in house a major study of the RIA profession.