In conversation with clients and industry colleagues, I am sometimes asked about UMB Fund Services’ approach to fund chief compliance officer (CCO) services—in particular, why we partner with third parties for fund CCO services rather than offering a CCO as part of our service package. The decision about how to obtain and structure CCO services ultimately comes down to a firm’s take on whether those services can and will meet requirements for critical factors such as independency, competency, knowledge, access and connectedness to the firm’s organizational culture. The following three questions, among others, have been helpful to us in evaluating these and other factors.
- How independent is the CCO? To what extent does he or she report only to the fund’s board of directors?
- How stable is the CCO relationship? Could it continue if a fund made a change in service provider?
- How focused is the CCO? Is he or she able to specialize to the extent needed?
Background
In 2003, The Securities Exchange Commission (SEC) adopted Rule 38a-1, otherwise known as the CCO Rule. The Rule requires funds to:
- Adopt and implement written policies and procedures that are reasonably designed to prevent violations by the adviser and its supervised persons of the Advisers Act and its rules and violations by the fund of the federal securities laws and the rules under those laws, respectively;
- Designate an individual as chief compliance officer (CCO) to be responsible for administering the policies and procedures; and
- Review the policies and procedures at least annually for their adequacy and the effectiveness of their implementation. Fund CCOs must also prepare a written report for the fund’s board of directors.
The SEC has communicated their preference for internal CCO’s because of their greater day-to-day knowledge and direct involvement in the firm, compared to a third-party. However, for many firms, this may not be an option either for economic reasons or internal knowledge and skills to assume the responsibilities.
Outsourced CCOs
Some firms may, for many reasons, have decided not to hire an in-house CCO. That’s where outsourced CCOs come into the equation. I would point to a 2015 Risk Alert from the SEC’s Office of Compliance Inspections and Examinations (OCIE). In that document, OCIE staff described applicable rules and its experience conducting examinations of firms with third-party CCOs, including “instances where the outsourced CCO was generally effective in administering the registrant’s compliance program, as well as fulfilling his/her other responsibilities as CCO.”
In describing these “generally effective” instances, OCIE staff noted, among other characteristics, “regular, often in-person, communication between the CCOs and the registrants; strong relationships established between the CCOs and the registrants; sufficient registrant support of the CCOs; sufficient CCO access to registrants’ documents and information; and CCO knowledge about the regulatory requirements and the registrants’ business.”
So, although there remains general acceptance that an internal CCO is best, the SEC has publicly recognized that third-party services can also be effective.
But in our view, that doesn’t mean all types of arrangements are equally suited to meeting the requirements for independence, stability and focus. For example, consider again the three questions noted above:
How independent is the CCO? To what extent does he or she report only to the fund’s board of directors?
In our view, independence could be compromised if a fund administrator offered CCO services in-house that oversees compliance matters of the other services it provides. Instead, we believe that CCO services should be provided by a different entity. This helps avoid even the appearance of the proverbial problem of the “fox watching the hen house.”
How stable is the CCO relationship? Could it continue if a fund made a change in service provider?
While we desire and strive to serve our clients over the long term, we recognize that outside factors sometimes lead to changes in administrators. One example is the purchase of one fund family by another. In these situations, we believe the fund would be compromised if CCO services are disrupted.
How focused is the CCO? Is he or she able to specialize to the extent needed?
However experienced and capable the CCO may be, when the individual’s responsibilities range beyond compliance areas, there exists the potential for distraction from the core responsibilities of being the CCO.
Closing thought
The bottom line is we believe the best structure for our clients is organizational separation between us as administrator and the individual serving as CCO. The individuals who serve as CCOs for our clients are highly specialized and work closely with the fund, advisor, board and UMB—while maintaining independence from UMB and all other providers.
UMB Fund Services is a national leader with decades of experience in registered and alternative investment fund servicing. Visit our website to learn how UMB Fund Services can support your firm, or contact us to be connected with a fund services team member.
