Market Troubles Pressure Compliance Departments

Cerulli says the current environment forces compliance departments to be more active, yet to operate more efficiently. Managing risk while the firm launches new products and the need this creates to employ specialists and implement new procedures creates pressure on asset managers’ compliance departments.  

“Investment firms will benefit from strong compliance throughout the organization, as long as it does not inhibit growth opportunities,” the report says. For firms with new, more complex products such as alternative funds, experts are required to help educate sales personnel on the nuances of these new products, and asset managers report to Cerulli analysts that educating wholesalers on products is their most time- and resource-consuming task.

Since compliance can be cumbersome and a drain on resources, Cerulli says it is important to have personnel with the right skills. Forty-two percent of asset managers Cerulli surveyed reported an expected increase in marketing compliance personnel, while at the same time, many compliance groups reported to Cerulli analysts that it is difficult to find and retain qualified people.

Nearly half of surveyed firms report that their compliance group is organized by business focus (e.g., retail, institutional, retirement plans), but Cerulli says it believes that firms with a significant product line benefit by organizing their compliance groups by a common denominator such as business focus, investment vehicle, or asset class – allowing for compliance specialists to become experts in their focused area.

To function at a high level, Cerulli says compliance groups need the support of top management. The report suggests top executives portray to the rest of the organization that they stand behind the responsibilities and decisions of the chief compliance officer and the compliance staff in part by physically locating compliance staff near executive officers.

More than half (57%) of Cerulli survey respondents indicated that their firms are staffed with three to five people dedicated to the marketing compliance function. Cerulli analysts suggest that the compliance staff, already spread too thin at many firms, should not be targeted for cost-cutting, as the function has become increasingly important.

In its latest Cerulli Edge report, Cerulli notes that, as it anticipated, the courts rather than the Securities and Exchange Commission or Department of Labor have provided guidance on the burden of disclosure faced by asset managers, distributors, and other third parties.

Cerulli makes a distinction between remuneration - virtually any type of payment from an asset manager to intermediaries in recognition of their distribution efforts - and revenue sharing - payments made to distributors directly from the asset manager's profit and loss statement. Cerulli asserts that the fact that true revenue sharing is paid out of the fund advisor's pockets and not fund assets, it should not necessarily need to benefit investors.

However, Cerulli argues that since revenue sharing practices are less transparent, investors would benefit from more disclosure.

The report notes that recent court judgments in revenue-sharing cases paint a mixed picture regarding the future of revenue sharing arrangements in DC plans. For example, in Martin v. Caterpillar, Inc., Caterpillar was sued for allegedly breaching its fiduciary duty in failing to disclose revenue sharing to participants. The corut ruled that plan sponsors currently have no fiduciary obligation under the Employee Retirement Income Security Act (ERISA) to disclose to participants details of any revenue-sharing agreements and potential conflicts of interest (see  Caterpillar Fee Suit Survives First Legal Hurdle ).

In another case, a Wisconsin district court judge initially dismissed similar charges against both the plan sponsor, Deere & Co., and the plan trustee, Fidelity, but, then, when the DOL intervened and filed an amicus brief alleging that Fidelity shares a fiduciary role in the selection and monitoring of the investment options as well as the disclosure of all plan fees, the case went on to appeals court (see DoL: ERISA Fiduciaries Could Have Disclosure Mandate not Specified in Law ).

There are still a number of cases tied up in the courts, and it may take years to reach verdicts and rule on appeals, Cerulli notes. In addition, there is no guarantee such verdicts will be uniform.

Going forward, Cerulli believes that all mutual fund industry players should prepare for the unexpected. "While each potential course of action (e.g., the sale of A-shares) should be balanced against an alternative (such as the sale of B-shares), firms cannot assume that one choice is above reproach, and must strive to adhere to suitability and fiduciary guidelines," Cerulli said. "Asset managers should test their business exposure to one type of share class or business arrangement, including "what-if" scenario testing (e.g., how would they cope if revenue sharing were compromised?)."

The Cerulli Edge reports may be purchased from here .