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US EAS T COAS T 2012 COMPLYING WITH THE 1940 ACT IN THE 21ST CENTURY WITH HIGHER REGULATORY BARRIERS THAN EVER BEFORE FOR US FIRMS, BRANDON LEMESH AND JULIA LEE OF EVENWHEEL SOLUTIONS (THE SOFTWARE ARM OF HEDGEOP COMPLIANCE) DISCUSS THE USE OF TECHNOLOGY TO EFFICIENTLY MANAGE A FIRM’S CODE OF ETHICS COMPLIANCE PROCESSES Brandon Lemesh is a senior client services associate for EvenWheel Solutions implementing compliance technology solutions for hedge funds, private equity firms and other private funds. Julia Lee is a client services associate for EvenWheel Solutions, implementing compliance technology solutions for hedge funds, private equity firms and other private funds. “ Now what” Since registering with the SEC, many investment advisors that have created their compliance policies and trained their employees have asked that same question. Monitoring employee Code of Ethics compliance is one of the more difficult aspects of an investment adviser’s compliance programme because of the sheer volume of information required to be reported and reviewed. Rule 204A 1 under the Investment Advisers Act requires that all investment advisers establish, maintain and enforce a written Code of Ethics, which includes provisions that require all access persons to report (and the CCO to review) their personal securities transactions and holdings. This must be done by submitting Initial and Annual Holdings Reports and Quarterly Transactions Reports of their reportable securities. Other required and best practice reporting includes political contribution, gift, entertainment and outside activity disclosures. The process of reviewing employee personal trading using paper broker statements has traditionally been tedious, inefficient and distracting from focusing on other business areas. The traditional review process of personal trading information can be broken down into three main parts: 1. Collection: Access persons have to request duplicate broker statements to be sent to the CCO using a ‘407 Letter’ and disclose any additional reportable securities, such as private placement investments, via paper forms. There can be a substantial delay from sending the letter to actually receiving the statements. The statements often sit in a large unopened pile and are not reviewed until a month or two after each quarter end, making it much more difficult to catch any Code of Ethics violations in a timely manner. In some cases, employees may not even realise that they are committing a violation and will inadvertently continue the violation for months until uncovered by the CCO. 2. Sifting: Broker statements contain much more information than is necessary and can be very confusing to read. A vice-president at a compliance consulting firm with approximately 10 years of experience described sifting through paper filings and brokerage statements as a “very manual and time-intensive process that includes physically sorting the personal trading information that has come in by access person and account” and “compiling a list of transactions in reportable securities”. Just sifting through the statements and preparing a spreadsheet took approximately 80 hours for a hedge fund with AuM of $10.8bn and 73 employees. 3. Review: Once all of the raw data is collected and transcribed into a more readable format, it must be reviewed to ensure compliance with the firm’s trading and pre-clearance policies. Although firms have different policies depending on the funds’ strategies, CCOs generally need to ensure that all transactions requiring pre-clearance were pre-approved and that employees did not trade in any of the securities on any restricted lists. This took two full working weeks for the $10.8bn AuM hedge fund mentioned above. In a paper world, every single transaction must be checked! Whereas the old method of sifting through paper statements was laborious and time-intensive, using a technology solution can help you track, monitor and document your Code of Ethics responsibilities efficiently. Products on the market, such as EvenWheel Solutions’ ELF Platform, include functionality that allows you to perform all of your employee-related compliance tasks, including personal trading, electronically. One of the major benefits of using software to manage your firm’s Code of Ethics programme is eliminating the number of paper brokerage statements that need to be reviewed manually. Many Code of Ethics software providers, through either a direct relationship with the financial institutions or through an account aggregator, have electronic links to brokerage firms. Having the raw data from a broker feed in electronic format allows the system to show only information that is relevant to the CCO in a clean format. This might include “filtering out” cash transactions, dividend reinvestments and other non-reportable securities from transactions reports before they hit the CCO’s eyes. EASY ACCESS Depending on how often these feeds are updated, you will have access to employee transactions and holdings information for review soon after a trade has been made, as early as the next day. This way, you can address any potential violations within days instead of months. In addition, if the 6 HFMWEEK.COM
COMPLIANCE system allows it, you can set up lists of securities (restricted lists, watch lists, holdings lists, and so forth) against which securities data is checked. As transactions and holdings data is downloaded and as trade pre-approvals are submitted, that data is automatically checked and compared against those internal lists, automating the approval and review processes. The use of software, in this case, can help an investment adviser transition to more of an exception-based system. The most obvious advantage of using a technology solution to help manage your firm’s Code of Ethics compliance program is electronically centralised and organised record-keeping of all your firm’s compliance-related documents. The use of software not only eliminates the need for physical storage space, but also allows you to respond to audit requests much more easily. The VP of a $2.5bn AuM private equity firm recently went through an SEC audit and noted that the SEC “came and went without much drama”, attributing the firm’s ability to respond to document requests quickly to its use of a technology product. Whether or not you choose to adopt a technology solution, it is important to note that while all products are designed around the same regulations, not all available products in the market are created equally. If you are considering implementing Code of Ethics software, here are four factors to consider before making a final decision, based on a sample of CCOs currently using technology. 1. Automation: The number of broker links a product has and how much automated review is performed on the raw data are crucial. If a product doesn’t have an electronic link to a broker, then most of the benefits of using technology won’t be realised. A product should be able to automatically reconcile pre-clearance requests against transactions, compare transactions to any restricted lists and perform other additional processes. Additionally, make sure to check whether or not you need to pay for each broker individually or if you get access to the entire world of brokers. 2. Security: Employees are generally rightfully concerned about how their personal financial information is being stored and used. It is extremely important to perform thorough due diligence on a prospective vendor’s IT infrastructure. This review should include evaluating the vendor’s data storage facilities, third party certifications (SSL, SSAE 16/SAS 70, penetration testing reports and so forth) and internal data handling policies. JUST SIFTING THROUGH THE STATEMENTS AND PREPARING A SPREADSHEET TOOK APPROXIMATELY 80 HOURS FOR A HEDGE FUND WITH AUM OF $10.8BN AND 73 EMPLOYEES ” 3. Ease of use: Realising the full benefits of using technology depends on an employee’s ability to use the software quickly and easily. You should consider the overall usability, look and feel of software during your evaluation. Ease of use is especially important for setting up new hires. The CCO at a $2.5bn AuM hedge fund described the onboarding process as, “extraordinarily efficient” since implementing software. The CCO also added: “We have a great relationship with our reps at the vendor, and they are happy to help [our employees], as necessary.” 4. Cost efficiency: Utilising software should obviously provide good value. Be sure to consider the full costs of implementing a solution for your firm, as some vendor costs might depend on your firm’s structure. Society has always progressed towards technology adoption for increased efficiency, and the private fund industry is no different. The investor relations team uses CRM software, traders and portfolio managers use OMS and compliance is next. In the words of a CCO who swears by technology:“The days of paper statements are old news.” ABOUT EVENWHEEL SOLUTIONS EvenWheel Solutions is the software arm of HedgeOp Compliance, LLC, which is part of The IMS Group, the leading global provider of regulatory compliance consulting services to the asset management and securities industry. EvenWheel produces world-class compliance software applications for investment advisers, hedge fund managers, private equity managers and other financial firms. n In a paper world, every single transaction must be checked HFMWEEK.COM 7
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