The role of the mutual fund chief compliance officer should be re-examined to take into account the risk-related responsibilities added to the job because of the market meltdown, according to industry experts, who say the job may have grown too demanding.
“I think managers ought to recognize that they have created a huge job with very big responsibilities,” said C. Meyrick Payne, a senior partner at Management Practice Inc., a consulting firm for independent fund directors.
It's a job that has grown considerably more complicated since 2004, when the Securities and Exchange Commission first required funds to appoint a chief compliance officer, he said.
As shellshocked investors have sought to diversify risk, CCOs have had to become versed in areas such as international investing and alternative investments that “weren't necessarily on their radar five years ago,” said Geoff Bobroff, a mutual fund consultant who works with fund boards.
Put in place in response to the market-timing and late-trading scandals that broke in 2003, CCOs have done a remarkable job of keeping mutual funds on the straight and narrow path, said Susan Wyderko, executive director of the Mutual Fund Directors Forum.
“I think they have very much worked in the way the [SEC] had hoped and anticipated,” she said.
Provoking questions about the role CCOs play in evaluating investment risks was the September 2008 collapse of the Reserve Primary Fund, advised by Reserve Management Co. Inc., which saw its net asset value fall below $1 and became the second money fund in history to “break the buck.” Greater-than-expected losses in life cycle and lifestyle funds also spotlighted the issue of whether the volatility of investments was being adequately disclosed.
To ensure that the fund prospectuses accurately describe the nature of their holdings, CCOs should be involved in the writing process, said Jeff Keil, president of Keil Fiduciary Strategies LLC, an industry adviser.
MORE INVOLVEMENT
In the absence of a chief risk officer, some fund firms are leaning on the CCO to get more involved across the board.
“A lot of organizations are thinking of investment risk, discussing "How much should we be asking of the CCO? from an organizational standpoint,'” Mr. Bobroff said.
“The propensity to overload the CCO is a real risk” and could be a big problem, he said. “We could end up with a diluted benefit, which to me is a concern.”
CCOs admit that their workload has increased, but they are leery of suggesting they are hampered in their ability to ensure compliance with rules governing everything from personal trading by portfolio managers to the adequate disclosure of conflicts of interest.
“While I do see there are challenges today with respect to different issues than five years ago, I'm not sure I see a dramatic change,” said Jim Davis, director of global compliance for
Franklin Templeton Investments, as well as chief compliance officer for the Franklin, Templeton and Mutual Series funds.
That said,
Franklin Templeton is a large firm with more than $539 billion in assets under management.
“A small fund complex is going to have different pressures and different expectations than a large, integrated complex like Franklin,” Mr. Davis said.
For example, at
Franklin Templeton, “there's much more focus by the fund boards on getting information directly from the business units,” he said. “That's the advantage of a large fund complex. In a small fund complex, that may become the responsibility by default of the CCO.”
The
recession has sparked a potentially transformative debate with regard to how investment risk should be evaluated, said David Lui, chief compliance officer at FAF Advisors Inc. and a former president of the National Society of Compliance Professionals. FAF advises First
American Funds Inc.
A “chief risk officer” should be created and “charged with the responsibility for testing and identifying risks that then have to be memorialized in a report to management and the government,” he said.
Some firms have such an officer, but it's not required.
“That structure could be remarkably effective to prevent the need for future bailouts,” said Mr. Lui. FAF manages more than 40 open-end mutual funds with more than $79 billion in assets under management and also manages $1 billion in eight closed-end funds.
Requiring a chief risk officer could also go a long way toward clearing up any confusion regarding the CCO's responsibilities concerning investment risk, potentially lightening the compliance officer's load.
It seems unlikely, however, that the SEC will take up such a cause.
FOILED BY SUCCESS?
“The SEC has so much on its plate right now, I don't see them addressing this or changing the [CCO] role formally,” said Mr. Davis.
SEC officials declined to comment.
To some extent, changing the rules is now more difficult because top compliance officers have been successful in preventing the types of problems that led the SEC to create the CCO position in the first place.
The Mutual Fund Directors Forum's Ms. Wyderko agrees that CCOs are dealing with new, unforeseen issues.
The only area that “leaps out” at her as a potential problem, however, is CCO oversight of outside firms that provide subadvisory and third-party services.
Service providers are a difficult issue for fund boards and CCOs,” Ms. Wyderko said. “There just isn't the same level and depth of information available about subadvisers and third-party service providers.”
Such information is needed to ensure that a fund isn't opening itself up to undue compliance risk, she said.
E-mail David Hoffman at [email protected].
