Outsourcing the Role of CCO
By Guy F. Talarico, Founder and CEO of Alaric Compliance
Originally published “Compliance Corner,” a feature of the Investment Counsel Association of America newsletter.
“whether in-house or outsourced, CCOs [must] be competent, knowledgeable, and empowered”
Editorial Note: Founded in June of 2004, EOS Compliance Services, LLC was succeeded by ALARIC Compliance Services, LLC in January 2006.
Rule 206(4)-7 under the Advisers Act and Rule 38a-1 under the Investment Company Act require investment advisers and registered investment companies to adopt and implement formal compliance programs. The selection of a Chief Compliance Officer or CCO, who is responsible for administering the firm’s compliance program, is a critical component of the compliance rule requirements. This article briefly outlines the benefits and risks associated with outsourcing the role of the CCO, and discusses considerations for selecting an effective outsourcing provider.
Many advisers are frustrated. They believe that their firms adequately provide for the necessary safeguard of their clients’ assets and they are dubious that additional requirements will provide any benefit. Moreover, they are concerned with the added expense and the anticipated administrative burden associated with fulfilling the role of CCO. Firms may consider forming an alliance with an outsourced partner to address some of these issues. The right outsourced partner can bring the competence and knowledge required to build and support the implementation and oversight of a firm’s compliance program. In addition, with adequate understanding of and routine involvement in the firm’s operations, an outsourced CCO may achieve the best results for some firms.
The SEC stated in the final release adopting the Rule 206(4)-7 that the CCO should be a single individual who is “competent and knowledgeable regarding the Advisers Act, and should be empowered with full responsibility and authority to develop and enforce appropriate policies and procedures for the firm.” The release further specifies that the CCO “should have a position of sufficient seniority and authority within the organization to compel others to adhere to the compliance policies and procedures.”
Individuals proposed for the CCO role range from the advisory firm’s president (or an individual that acts in a similar capacity) to very junior level employees. While the president of an advisory firm presumably has the seniority and authority necessary to enforce the compliance program, he or she may lack appropriate knowledge of the Advisers Act and related no action letters, releases, administrative proceedings, conference materials, and other relevant presentations necessary to administer the role of CCO. Deriving and overseeing the appropriate compliance program from theses sources requires considerable focus and expertise. Additionally, as a practical matter, the president may not have sufficient time to devote to the oversight of the firm’s compliance program. Additionally, a firm that appoints its president as CCO must also be particularly diligent about the oversight of the president with respect to compliance protocol and potential conflicts of interest.
On the other hand, the appointment of a junior level employee to fulfill the role of CCO raises the same issues associated with knowledge and expertise, and raises the added issue of appropriate empowerment. Further, such an individual may be reluctant to voice apprehension about assuming the responsibilities associated with being the CCO and the personal liability that may accompany them. An advisory firm that seeks to identify a CCO within its firm (or to recruit a new employee to fulfill the role) should be diligent about identifying an individual with sufficient seniority and expertise, as well as sufficient time to devote to the role of CCO. Alternatively, an advisory firm may consider outsourcing the role of CCO. Given the extensive roles already played by outside service providers in the operations of most mutual funds, an outsourced CCO could be a very natural choice. There may also be circumstances where an outsourced CCO is also the most appropriate choice for an investment adviser.
Some of the benefits of using an outsourced CCO can include: (1) continual access to appropriate knowledge of the Advisers Act and related legal and regulatory requirements; (2) knowledge and competence regarding industry “best practices” garnered through involvement with multiple firms; and (3) a cost effective alternative to the salary of a qualified in-house CCO.
However, when considering whether or not outsourcing is appropriate, firms should evaluate the issues of proximity of the outsourced CCO and the outsourced CCO’s potential competing commitments. As the CCO is responsible for adopting and implementing the firms compliance program, there is a presumption that the CCO will be intimately familiar with the firm’s operations. Firms should consider how to ensure that the outsourced CCO will be routinely involved in the operations of the firm. Moreover, the CCO should project an “atmosphere” of compliance that reflects the tone at the top. In order to achieve these objectives an outsourced CCO must make a substantial commitment to establish a true on-site presence at the firm. This may be difficult if the outsourced CCO is located across the country. When evaluating current and potential competing commitments that may detract from an outsourced CCO’s ability to perform his or her role effectively, firms should also be clear about general expectations of time commitment.
An effective outsource provider will be fully aware of the issues of proximity and competing commitments, and of the consequences of failing to meet a firms compliance requirements. Regardless of whether in-house or outsourced, CCOs are expected to be competent, knowledgeable, and empowered and are responsible for assessing, developing, and implementing their firm’s compliance programs. The recent Strong Capital Management case clearly demonstrates the risks associated with failure to fulfill these obligations. The selection of an outsourced CCO may be an appropriate consideration for firms when evaluating these expectations and risks, and ultimately determining the most appropriate approach for their firm.