For most wealth management firms, compliance technology is an afterthought. What is that department even doing all day besides looking for ways to restrict our business? Why make their job easier with technology when they’re not generating revenue for the firm? In reality, compliance departments are busy behind the scenes protecting the firm and making sure all things are in good order when the regulators come knocking.
We’ve written in the past about the business case for technology integration and compliance is no exception. A compliance technology strategy that integrates compliance tools with firms’ CRMs, portfolio management systems and other internal technologies supports growth, helps avoid risks and protects the clients’ best interests. Understanding the compliance team’s functions helps advisors fully appreciate the need for integrated technology solutions.
Here we summarize some of the responsibilities of this department and describe how integrating technology solutions with other areas of the firm helps achieve compliance and avoid costly penalties.
Electronic business communications such as email, text/application messaging, or social media posts must be properly archived in accordance with SEC Rule 204-2. Failure to maintain proper recorder-keeping has been a recent focus of regulators. In August 2022, Morgan Stanley agreed to pay $200 million to U.S. regulators to resolve investigations into its record-keeping practices. As new avenues of communication and collaboration tools gain popularity, compliance departments must be agile in establishing ways to capture and archive messages for oversight review.
Having a technology that can easily integrate with popular communication channels to collect, store and supervise can be critical to firm growth and avoiding costly penalties. Three common industry archiving tools that have integrations are Smarsh, Erado and Global Relay.
Client Account and Activity Oversight
Large RIAs often have options for financial advisors to perform the discretionary trading and management of client accounts under a Rep as PM (RPM) program. RPMs come with increased scrutiny and a greater emphasis on oversight to ensure accounts are being managed according to fiduciary standards. Enacting a framework to supervise and enforce RPM programs is necessary.
Compliance departments must proactively address portfolio risks such as over-concentrated positions, reverse churning (see explanation below), improper allocation, performance outliers against benchmarks and deviations from client risk tolerance and objective. By integrating portfolio management software with a rules-based engine to flag for these risks, compliance teams can spend less time with inefficient manual spot checking and more time helping advisors to correct misaligned portfolios.
Reverse Churning happens when an advisor charges ongoing fees to a client account, while the account remains idle. Three American International Group (AIG) advisory firms paid about $10 million to settle federal charges for failing to monitor fee-based advisory accounts for inactivity, or “reverse churning”.
Employee Trade Monitoring
SEC Rule 204A-1 requires firms to review all “access persons” personal securities transactions and holdings periodically. With the help of software tools, firms can create an automated pre-clearance process and electronically capture employee personal trades for post-trade review. However, front-running remains difficult to monitor and detect. The consequences for firms found guilty of this illegal practice can be damaging both financially and in reputation – and may even include jail time for violators (https://www.sec.gov/news/press-release/2021-186).
Proper oversight requires eyes on both employee and client activities. Yet, many compliance teams have siloed internal systems, making it difficult to compare employee and client trades simultaneously. Through an integrated approach, firms can bring together trade surveillance tools with internal trading systems to help spot these violations. This approach will give compliance officers the confidence of knowing that their employees aren’t violating the firm’s code of ethics rules.
Annual Compliance Questionnaire and Attestations
While an Annual Compliance Questionnaire may feel unnecessary to advisors, this document’s purpose—to collect data to check for conflicts of interest, provide annual updates, confirm employees’ acknowledgements of firm policies and procedures and identify risks for the firm—is really quite important.
For larger firms without a technology strategy, disseminating, collecting and reviewing responses on these forms is unnecessarily burdensome. Distribution of the questionnaire in a digital form that can be integrated back into firm technologies, such as CRM, can be a huge time saver for compliance teams who need to efficiently review responses. Digital attestations are also more easily tracked to ensure all employees have completed their responses.
SEC Reporting (13F)
If you have $100 million in discretionary assets or more, you must file a 13F quarterly holdings report with the SEC within 45 days of each calendar quarter end. The SEC requirements for this report include qualifying securities (based on the SEC Official List: https://www.sec.gov/divisions/investment/13flists) aggregated across your firm, with number of shares, CUSIP and market value reported. Pulling this data may be a time-consuming process for compliance departments without proper technology, especially if you are a large, multi-custodial firm. Data mining the necessary information becomes much easier with portfolio management software, reconciled with integrated custodial position and transaction files.
Standalone tools exist to support the compliance team’s activities, but to be truly effective, integration with other internal solutions is essential. By investing in an integrated technology strategy with thoughtful design, you can alleviate many of the risks and manual processes that plague growing firms.
Looking for support with your compliance technology strategy, get in touch to learn how we can help.