So Many Regulations, So Little Time: Buy-Side Firms Try Outsourcing Compliance
Originally published in Windows in Financial Services
Editorial Note: Founded in June of 2004, EOS Compliance Services, LLC was succeeded by ALARIC Compliance Services, LLC in January 2006.
Some asset managers are responding to the growth in regulatory demands by outsourcing their compliance.
NEW YORK, July 2005:
It may seem a bit counterintuitive (how can someone who doesn’t work in the building keep up with a lot of traders and portfolio managers?) but for managing the highly quantifiable rules issued by the SEC it has proven attractive to small and medium size funds. These buy-side firms are finding outsourcing a lot cheaper than hiring the expertise onto their staff.
“Some asset managers are responding to the growth in regulatory demands by outsourcing their compliance.”
The number of requirements from regulators will only grow, said Mike Gamson, director of Advent Software’s trade order management and compliance group, and that could lead more firms to outsource their compliance.
“Registered investment advisors, mutual funds, and hedge funds are being held to new regulations, including having a designated chief compliance officer who has to follow certain rules,” he explained. “That is a burden.”
Enter EOS Global. Based in New York, it works with a growing number of funds with a total of $20 billion under management. In some cases it simply provides consulting, but for nine of its investment firm clients, one of the EOS executives serves as chief compliance officer.
“We become officers of the fund on an outsourced basis,” explained Guy F. Talarico, co-chief executive officer of EOS Fund Services, “and we do all the reviews required by the SEC.”
For registered financial advisors they take the same approach. The company’s executive becomes an officer of the firm through an engagement letter, and is covered by the firm’s errors and omissions and director and officer’s policies.
“When you think about the way mutual funds are structured, virtually all the service providers are outsourced entities, so it is the most natural extension to have an outsourced CCO. You have the money manager as an advisor, the transfer agent, the administrators, the custodian – and they are not part of the fund legal entity,” said Talarico.
For asset managers, outsourcing means they have access to the expertise of a team of experts for far less than the $250,000 to $750,000 they would have to pay for an in-house compliance officer.
EOS is one of the first companies to specialize in pure compliance outsourcing. The company is staffed by people with MBAs, legal and accounting degrees and experience in investment management, brokerage, and custody.
To get started, EOS works from a firm’s existing technology, which in the case of several clients means Advent’s portfolio management and accounting applications. The compliance team downloads information from the accounting system to Excel and examines information through side-by-side comparisons to look for trading patterns that might violate SEC guidelines. It checks brokerage records to see if the fund might be rewarding broker dealers who distribute its products, and looks for violations such as employee trading in equities that the fund is buying or selling.
EOS has also hired Financial Tracking, which does VWAP (volume-weight average price) analysis to monitor executions on a daily basis. The firm will take an extract from the Advent system and produce a best execution trading report.
To meet the demands of the SEC in the future, Talarico expects that portfolio management and accounting systems like Advent’s will provide enhancements that detail the information that compliance officers need from the data the applications already collect; the systems will simply have to provide data in a different form.
“A lot of compliance reporting could be done from information in the Advent system as it is,” he explained. “We have suggested certain enhancements that could take it to the next step.”
Advent’s portfolio accounting and trade order management solutions currently contain a variety of compliance functionality that many clients use regularly to report to the SEC, said Gamson. Meanwhile with Advent’s Moxy system, firms can set up rules and restrictions to prevent trading violations.
In addition to working with managers who use Advent, EOS has clients using proprietary systems and other portfolio accounting software, such as SS&C’s Camra.
Compliance is not, of course, simply a matter of numbers in reports. As the compliance officer for asset managers, EOS acquires other responsibilities, such as rules for email. Here it takes a broad approach, telling its clients that they need to maintain copies of all emails or follow SEC guidelines on emails that they discard.
“The SEC has given pretty good guidance. If you are going to delete emails, it has to be in conformity with explicit policies,” said Talarico.
“The SEC is entitled to certain books and records produced in the business,” Talarico explained, as he has done to clients, who were often less than thrilled to receive this information.
“To the extent that those records are distributed through emails, the SEC is entitled to them.”
Clients should make sure they have backups of all emails, including those deleted, in case the SEC wants to review them. Traders, a fairly verbal lot, have often been shocked by this, he said.
“I tell them, if you use foul language about a broker, you can’t delete that. We have encouraged firms to focus on the use of email. We suggest that they encourage people to be cautious in their use of words and be careful about trying to convey a joke or a comment tongue in cheek, because humor doesn’t always translate well. We have also said that no personal business should be conducted through business email,” Talarico said.
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Alaric Compliance Services, LLC