The Securities and Exchange Commission (“Commission” or “SEC”) recently instituted settled administrative and cease-and-desist proceedings against a chief compliance officer of a registered investment adviser for record retention and record provision violations.1 It is not often that the Commission directly charges a chief compliance officer (“CCO”). Accordingly, this action provides valuable insights to other CCOs on how to discharge their compliance duties. Specifically, the proceedings highlight key “dos” and “don’ts” when documenting compliance reviews, determinations, and other key compliance documents:
- “Do not” procrastinate documenting compliance reviews and determinations. This is best done at the same time reviews are conducted and determinations are made. At the very least, be sure to take contemporaneous substantive notes of the facts and analysis underlying the reviews.
- “Do not” backdate documents to make them appear as if they are a contemporaneous memorialization of events when they are not.
- “Do not” withhold documents from the SEC’s examination staff, even if you think certain documents may be harmful to your firm.
- “Do” acknowledge that a document is not contemporaneous if you are documenting compliance reviews and determinations after the fact.
- “Do” review and rely on substantive contemporaneous notes of the facts and analysis underlying the compliance reviews and determinations if you are documenting compliance reviews and determinations after the fact.
The SEC’s settled action focused on the CCO’s documentation of a compliance review and determination involving a research analyst’s potential possession of material non-public information (“MNPI”) regarding a company (“Company A”) in which the investment adviser was considering investing its clients’ assets. Namely, the CCO interviewed the analyst before the adviser’s investment and determined that the analyst did not possess MNPI regarding Company A. After the adviser invested client assets in Company A, the CCO’s supervisor asked the officer to memorialize the interview and the CCO’s conclusions out of concern about possible future regulatory inquiries. In response, the CCO created and saved a blank “memo to file” that contained only the subject and date, but no content. The next day, Company A announced an agreement to be acquired by another company.
Eleven months later, after receiving an inquiry from the supervisor, the CCO drafted and backdated two versions of a memorandum that purported to memorialize the CCO’s reviews related to the investment in Company A – one dated before acquiring an interest in Company A and one dated after. The CCO did this without reviewing any substantive, contemporaneous written analysis or notes of the prior year’s events. Both versions contained multiple factual inaccuracies.
Six weeks later, in response to an SEC examination request, the CCO produced the earlier backdated memo to the SEC exam staff and represented in the cover letter that it was a contemporaneous memorialization of the events it described. Eventually, both versions were provided to SEC’s enforcement staff in response to a subpoena.
The Commission found that the CCO had willfully aided and abetted and caused the adviser’s violation of Section 204(a) of the Investment Advisers Act of 1940, which provides the SEC with authority to require an investment adviser to maintain records and provide reports as well as to examine records. The CCO, among other things, was censured, ordered to pay a civil money penalty of $25,000, and prohibited from acting in a compliance capacity with any broker, dealer, or investment adviser for three years. She was also barred from practicing before the Commission as an attorney for one year.
These proceedings show the importance of contemporaneously documenting compliance reviews and determinations or, at the very least, taking contemporaneous substantive notes. More importantly, it counsels CCOs to date such reviews accurately. Indeed, the CCO could have likely avoided SEC charges if she had accurately dated the review and based it upon substantive contemporaneous written analysis and notes of the prior year’s events.
Finally, the proceedings show that candor and transparency with the SEC’s examination staff is critical, as the Commission does not take kindly to conduct that delays and impedes the staff’s inquiries. To that end, the Commission stated within its Order that “[t]he Commission’s examination authority is fundamental to its ability to protect investors by monitoring investment advisers’ compliance with the federal securities laws. Employees of regulated entities may not undermine this crucial component of Commission oversight.”2 Thus, the SEC will act decisively to maintain the integrity of the examination process.