11/30/2011 10:15:00 AM EST
Compliance Officer Banned in the United Kingdom
As a compliance officer, I often find that many lessons
come from enforcement actions. Those actions imposed on compliance officers are
especially instructive. The latest to catch my attention comes from the United
The Financial Services Authority levied a £14,000 fine
and banned a compliance officer from performing any significant influence
function in regulated financial services. The circumstances arose from an
employee's attempt to conceal losses after the collapse of Lehman Brothers in
Dr Sandradee Joseph was Compliance Officer at Dynamic
Decisions Capital Management (DDCM), a hedge fund management company based in
London. One of DDCM's funds suffered catastrophic losses during the fall of
2008, losing 85% of its assets under management. A fund employee, rather than
report the losses, decided to enter into a complicated bond transaction to
create false profits. Essentially, the employee was buying bond units at a steep
discount, but reporting a much greater value when calculating the fund's NAV.
The fund had lost $255 million, but the employee booked a $268 million gain on
the bond transaction. A bond that the fund had only paid $5 million.
Three problems arose that the FSA thinks were instances
of the compliance officer not doing her job.
The first was that the fund's prime broker terminated its
agreement with the fund because of the bond transaction. Any trade that causes
the prime broker to leave should be a big red flag.
The second was an unhappy investor. The investor had put
$48 million into the fund. The bond happened to violate some of its investment
restrictions: maturity greater than 12 months, issued by an unlisted entity, no
option to convert equity, and greater than 3% of the fund's NAV. Violations of
an investor's investment guidelines should be a big red flag for a compliance
The third problem was another unhappy investor. The bond
transaction also violated this investor's permitted investments limitation. A
second big red flag that the compliance officer failed to remedy. This investor
dug a bit deeper and felt that the bond may have been fraudulent.
The compliance officer tried a few defenses that sound
weak to me. They sounded weak to the FSA as well.
compliance officer's role was a reporting function and it was up to
individual employee to ensure compliance.
compliance officer was not the fund's lawyer and she could take a back
seat on legal matters.
compliance officer felt enough advisers were looking at the issue.
compliance officer did not understand the bond and was relying on external
lawyers to review it. (However, she never instructed a law firm to
to carry out due diligence on the bond.)
compliance officer believed the bond was legitimate. (Even though she
disclosed that she didn't understand it.)
The FSA lays out the lesson learned: "In her role, if
[the compliance officer] became aware of concerns that the firm was not
complying with its regulatory obligations, she should have taken steps to
ensure that these concerns were investigated, to verify if the concerns
appeared to be legitimate, and if so to take appropriate action."
As a compliance officer, I initially found the punishment
to be on the harsh side especially since it seems to single out the compliance
officer. Then I dug a little deeper and saw that criminal
investigations were started by the SFO and the investors filed suit against
additional commentary on developments in compliance and ethics, visit Compliance Building,
a blog hosted by Doug Cornelius.
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