SEC wants mutual fund certification in writing

WASHINGTON — SEC examiners want chief compliance officers of investment advisers affiliated with mutual funds to certify, in writing, the firm's compliance with its policies and procedures.

The request — on a questionnaire provided to an investment adviser during an inspection earlier this year — surprised most observers because it is not part of any securities rule.

In addition, staffers at the Securities and Exchange Commission are routinely asking chief compliance officers to provide "exception reports together with documentation of follow-up work," as well as lists of compliance breaches documented since the inception of the firm, all on company letterhead and signed by the chief compliance officer or the president.

And in a combined examination of an unidentified mutual fund company and its affiliated investment adviser in September, the Chicago regional office of the SEC asked for a written list of "all violations of the law, material compliance problems or other significant matters that have occurred since the last inspection that registrant(s) think we need to know before commencing the exam."

"It's outrageous," said Mari-Anne Pisarri, partner in the Washington law firm of Pickard and Djinis LLP, which specializes in securities regulation. "Leaving aside the Fifth Amendment (self-incrimination protection), I have a problem with asking you, the compliance officer, to put yourself on the line," she said.

Ms. Pisarri and other securities lawyers said they're generally instructing clients to refuse to sign such certification letters.

Barry P. Barbash is a partner in the Washington office of the law firm of Shearman and Sterling and director of the SEC's division of investment management in the mid-1990s. He said the SEC's motivation behind the certification probably is to make the best use of limited resources by relying on the certification letter to spend less time on an exam. But investment managers worry that it could be used against them, and Mr. Barbash worries that because lying to a government official carries criminal penalties, chief compliance officers who provide certifications to SEC examiners might be risking personal liability if the securities regulator uncovers problems in subsequent inspections. "The SEC could say that is not the case, but it could happen," Mr. Barbash said.

Gene A. Gohlke, associate director in the SEC's office of compliance inspections and examinations and the person who oversees reviews of investment advisers and mutual fund companies, did not dispute that assessment. "Yes, it's a chance they take," he said, although he explained that chief compliance officers who can show they've been diligent in setting up and applying compliance policies and procedures "might have a good defense."

The SEC had sought to include a certification provision when it proposed its compliance rule at the beginning of 2003. An outcry from the investment management industry forced the regulator to excise the provision from the final rule issued last December. Sources suggest the SEC could have adopted the certification mindset from the Sarbanes-Oxley law of 2002, which imposes certification requirements on chief executive officers and chief financial officers to ensure the accuracy of their companies' financial statements.

But Mr. Gohlke said certification by the chief compliance officer, while not required, is a current practice, and "I don't know of any present initiative to change that practice."

Although most of the requests for certification by compliance officers have emerged in examinations by the Chicago regional office of the SEC, according to sources, Mr. Gohlke said it is a nationwide practice, typically requested in routine inspections but not generally sought in focused examinations commonly known as "sweeps." Mr. Gohlke said that the regional offices have reported getting certifications, although he couldn't quantify them.

In instances where chief compliance officers decline to sign the certification, SEC inspectors might conduct greater scrutiny of the firm, ask for more documents and conduct more tests of policies and procedures, he said. SEC examiners might wonder "what it is they're trying not to disclose and, as a result, we may do a lot more work during an exam," Mr. Gohlke said.

"There is nothing in the rule that requires chief compliance officers to provide the SEC with such a certification, but it does put the chief compliance officer in an awkward position when the SEC asks for such a certification," said W. John McGuire, a securities lawyer and partner in the Washington office of Morgan, Lewis & Bockius LLP.

Mr. McGuire said his firm recently advised a client to refuse to provide the certification, "absent the SEC coming back and providing more authority for a certification."

Ms. Pisarri also puzzled over why the SEC is creating more paperwork, because a new ethics rule already requires all supervised employees of investment advisers and mutual funds to report violations of securities laws to the chief compliance officer or the designee. The rule also requires money managers to keep track of changes made in the firm's policies and procedures to get back into compliance.

"Presumably, if there's a violation of any federal securities law, that translates into a violation of the ethics rule, and you have to keep a record of any action taken as a result," she noted.