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SEC Commissioner Daniel Gallagher published a statement explaining his dissent in two recent enforcement actions in which the Chief Compliance Officer of an investment adviser was charged, noting that the trend in such actions is toward strict liability. “Statement on Recent SEC Settlements Charging Chief Compliance Officers with Violations of Investment Advisers Act Rule 206(4)-7." The Commissioner called for guidance for COO’s who are critical gatekeepers. This is not the first time the Commissioner has spoken out on behalf of COOs (here).
The two enforcement actions which prompted the dissent are In the Matter of Blackrock Advisers, LLC, Adm. Proc. File No. 3-16501 (April 20, 2015) (here) and In the Matter of SFX Financial Advisory Management Enterprises, Inc., Adm. Proc. File No. 3-16590 (June 15, 2015) (here). In each the Commission charged the firm’s COO with violations of Advisers Act Rule 206(4)-7. The former centered, in part, on the question of whether the firm had adequate policies and procedures to monitor the outside activities of employees and disclose conflicts to fund boards and advisory clients. The latter focused on whether the firm’s policies and procedures were sufficient to detect a multi-year fraud. Each CCO settled.
Rule 206(4)-7 is at the center of the Commissioner’s concerns. The rule is “not a model of clarity,” according to Commissioner Gallagher. It provides, in part, that the adviser is required to adopt “and implement written policies and procedures reasonably designed . . .” to prevent violations of the Act. On its face the rule addresses the adviser – it requires the firm to designate a CCO. While the adviser is responsible for implementation, the SEC interprets Rule 206(4)-7 as if it is directed to CCOs.
The rule also offers “no guidance as to the distinction between the role of CCOs and management in carrying out the compliance function,” the Commissioner noted. The SEC has offered none in the years since the enactment of the rule except through enforcement actions which at times have “unfairly contorted the rule to treat the compliance function as a new business line, with compliance officers assuming the role of business heads.”
Enforcement actions are not the way to resolve the uncertainty surrounding the rule, according to Commissioner Gallagher. Rather, the Commission should consider the message sent to the compliance community of resolving the ambiguity inherent in the rule through enforcement actions. Those actions have a “psychological impact, and in many cases [cause] reputational damage . . . [from] months or years of testimony, the Wells process, and settlement negotiations . . . [that can be] as chilling as the scarlet letter of an enforcement violation” he stated.
Yet CCO are critical gatekeepers, necessary to effectively implement compliance programs. They are “all we have. They are not only the first line of defense, they are the only line of defense,” Commissioner Gallagher argued. Viewed in this context, it is imperative that the Commission “take a hard look” at the rule and consider if amendments or at least agency or staff guidance is necessary.
For more news and commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.
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