Hit for the cycle

(June 2006) Do you have the sneaking suspicion you’re doing something not quite right. Well, it might be more than a suspicion. “What did your latest audits find firms were doing wrong?” is the question we put Karen McGuinness, compliance chief at the Mutual Fund Dealers Association. Her response: “Everything.”

All the problems the self-regulatory organization ranted about after the first set of cycle exams are still there and the regulator is frustrated by the light touch applied by some firms that were asked to beef-up compliance. “It’s not like they took the report and laughed and threw it in the garbage can,” McGuinness said. “They do some things but they don’t go all the way.”

To some extent, that’s to be expected because MFDA’s secondround audits are set up on a risk basis – meaning that firms found to have serious problems during the initial exams are the ones being visited now. The better-behaved operations will be reviewed later. There are a few exceptions, notes McGuinness. If a high-risk firm is located in an area where there aren’t a lot of other mutual fund dealers, then lower-risk operations nearby will get visited in order to save travel costs for MFDA staff. Likewise, if MFDA auditors are working at a larger firm, and human resources are stretched thin, the association may opt to have a smaller team visit a well-behaved smaller dealer in order to maximize productivity.

“We’re still at the top 1% now,” she says. “It will likely take us three years to get through the second cycle.” The exams are concentrating at the dealer level and McGuinness says the regulator will have a better idea about how well firms are responding to requests for improvement a year from now. “Firms tend to do the easy things, like changing the new account application form,” McGuinness says. “But they’re not doing things like instituting a proper trade supervision policy, because that would call for additional staffing or for computer systems being purchased.”

And, make no mistake, the MFDA does intend to carry out its threat to refer firms that fail to make improvements to enforcement. In fact, says McGuinness, case files from recently examined firms are on their way down the hall. Meanwhile, a lot of dealer firms say they wish the MFDA would spend less time on examinations and put more effort into clarifying rules to make compliance easier. They note that frequent minor rule changes cause them to have to reprint account opening forms, an expensive proposition, or that document requests (such as for GIC capital requirements certificates) are antiquated because they don’t acknowledge the paperless nature of those transactions.

Others simply wish for the MFDA to vanish and have its regulatory duties taken over by the Investment Dealers Association. They cite the recent merger between IDA and RS as a sign the time is right to further consolidate and simplify regulation of firms selling a variety of securities products. But it’s not that simple. Such a change would have implications for registration and licensing requirements. And do you really think the MFDA won’t defend its right to exist? Once a regulator is created, it rarely bows out. RS was an exception, not the rule.

The question mutual fund dealers need to ask themselves is this: Do you want your regulator to grow up, or not? The MFDA was created only a few short years ago. It’s an infant on the regulatory continuum and will experience growing pains for years to come. Cycle exams, even if they’re annoying, are part of that growth process and will help the regulator learn which cases need to get sent to enforcement, and which can be dealt with using non-punitive measures such as letters of caution.

And, really, far from feeling harassed, you should be rooting for your regulator to keep its word and clean up your industry. If your firm is compliant with nothing to hide, then you have nothing to fear from an exam. It’s your rogue competitors that should be worrying. Sure, exams are a hassle, but the U.S. still holds the trump card on multiple visits by regulators, with the average firm getting seen by federal regulators, two or more SROs, state examiners, and state insurance commissioners and attorneys general.

Think about that the next time you start clamouring for a national securities regulator.

AER

(06/15/06)