Mutual Fund Compliance Chiefs Are in the Hot Seat

Newspapers have ombudsmen who field complaints from readers.

Police departments have internal affairs squads that investigate alleged misdeeds by cops.

And now every mutual fund has its own version of a sometimes thankless job: the chief compliance officer.

“I’m now in this Bermuda Triangle,” said Chris Thomas, chief compliance officer at First Pacific Advisors in Los Angeles, which runs the FPA Funds. “I’m in a lot of crosshairs.”

Some of the bigger mutual fund companies have had compliance officers for years. Since October, however, the Securities and Exchange Commission has required these positions at all funds -- a response to the trading and sales scandals that have rocked the $8-trillion industry beginning in 2003.

One financial website has quipped that the job duties include “willingness to spend time in prison as the scapegoat for SEC investigations.”

“It’s a fairly daunting task,” concedes Lori Richards, the SEC’s compliance and inspections director. “This is an environment where there have been many serious violations in the industry, including some by senior managers, and lots of enforcement actions.”

The job entails ensuring that funds are following investment laws and company ethics standards. For example, compliance officers monitor personal stock trading by firm employees for potential conflicts of interest, and examine securities trades to ensure that they are priced in a timely and accurate fashion.

Even as they wield clout within their firms, compliance officers can be seen as serving three masters -- hence Thomas’ half-joking reference to the Bermuda Triangle.

On matters of compliance, they are meant to be the “eyes and ears” of the fund boards to which they report, Richards said.

In most cases, however, they are paid by the advisory firms that manage the mutual funds, not by the boards to which they report or from fund assets.

Finally, though they are not deputies of the SEC, they are the agency’s “allies” in a mission to protect investors, as Chairman William H. Donaldson put it recently at an industry conference in Palm Desert.

First Pacific Advisors, a value-oriented mutual fund company that controls $9 billion in assets, used to rely on its outside attorneys for guidance on compliance issues, Thomas said, and the firm had a clean record in its SEC examinations over the years.

The new rule requires a designated compliance chief, however, so Thomas, long-time controller and vice president at the firm, was given the job. Thomas said that it took up about half his time and that he had hired an assistant.

He said the firm’s portfolio managers had always demanded “best execution” -- industry slang for buying and selling stocks efficiently -- but now the trading process must be meticulously documented.

“There’s a saying around here that if best execution is not achieved, the next execution will be the trader,” Thomas said.

For its part, the SEC says it wants a cooperative, not hostile, relationship with compliance officers.

At the Palm Desert event, Donaldson announced an outreach program intended to spark communication between the agency and compliance officers, stressing that he would not try to “deputize” them as agents of the commission.

Under the program, the SEC will invite compliance personnel to regional and national conferences and publish a regular newsletter with tips and updates.

For their part, compliance officers are invited to call the SEC to discuss concerns or questions.

“If they find something serious, we would hope they call us up and tell us rather than wait for the next SEC exam,” Richards said. “There’s no regulatory obligation, but as good fund citizens you would expect them to do it.”

Some firms, such as FPA, have appointed a single executive to head compliance at the management company that advises the funds and at the funds themselves. (Technically the funds and the investment companies that advise them are separate entities.)

Other firms, such as Ariel Capital Management in Chicago, have split the job. At Ariel, former SEC attorney Wendy Fox handles compliance for the investment advisor. Anita Zagrodnik, a former auditor at a major accounting firm, manages the duties at Ariel Funds.

“It’s a good check and balance,” Zagrodnik said.

Last month, they reminded employees that under a new policy, gifts exceeding $50 in value from anyone doing business with the firm must be reported.

When the firm was drafting the policy last year, it avoided setting a lower limit that might have been cumbersome.

“You can’t over-compliance people,” Zagrodnik said.

Still, noodging is a necessity of the job.

Zagrodnik says her auditor mentality comes into play whenever she gets reports from accountants, record-keepers and other outside service providers Ariel uses. Rather than accept numbers such as fund assets and liabilities at face value, for instance, she may call the third party to ask how they were calculated and verified.

“I’ve challenged service providers quite a bit,” she said. “That can be annoying to them but they understand.”

Some fund companies question whether the new compliance rule is worth the money and management time it requires.

“In trying to protect the investor, the SEC has increased total expenses and given them less choice,” said Nicholas D. Gerber, portfolio manager of the Ameristock mutual fund and founder of its investment advisor, Ameristock Corp. in Alameda, Calif.

“We got in this business 10 years ago to manage money, and nowadays we’re managing paperwork,” said Howard Mah, an Ameristock co-founder who became compliance officer last fall.

Despite the burden, Thomas at First Pacific Advisors said it beat the alternative of heavier regulatory oversight.

“It’s superior to multiplying the SEC to the degree necessary to put a cop on every corner,” he said. “Can you imagine what that would cost the government?”

Diane E. Ambler, partner at law firm Kirkpatrick & Lockhart in Washington, agreed.

“The idea is, independent directors really get to kick the tires and make sure everything is operating as it should,” she said. “The structure imposes a discipline to ensure that that occurs.”