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Compliance

There are many ways in which fund complexes pursue the development and implementation of effective compliance programs, and there is no one “right” approach to compliance. Nevertheless, the characteristics of a strong fund compliance program include an ethical, compliance-focused “tone at the top”; a collaborative approach by the fund’s chief compliance officer (CCO) and fund management; a risk-based program tailored to the fund and the adviser’s business; transparency and candor among the CCO, fund board, and adviser; and knowledgeable staff armed with appropriate resources.

Regulatory Responsibilities

The 1940 Act has a fund compliance program rule, which provides fund boards with tools for overseeing compliance, along with specific responsibilities relating to the compliance function. In particular, the rule requires that:

(i) the board approve the fund’s policies and procedures, as well as those of each investment adviser, principal underwriter, administrator, and transfer agent of the fund; and 

(ii) the board approve the designation, compensation, and removal of a fund CCO. 

In addition, the CCO, at least annually, must:

(i) provide a written report to the board that, at a minimum, addresses the operation of the fund’s policies and procedures and each material compliance matter that occurred since the date of the last report, and 

(ii) meet in executive session with the fund’s independent directors. 

Beyond these specific requirements, the rule offers little guidance on its implementation. As a result, each fund complex has developed its own compliance framework based on its own facts and circumstances.

to learn more
Read the IDC task force paper Board Oversight of Fund Compliance.

Fund Chief Compliance Officer (CCO)

Though the compliance program rule requires the CCO to provide a written report to the board and to meet separately with the independent directors “no less frequently than annually,” it is common for a CCO to attend every board meeting—in many cases, for the full length of the meeting. In addition, many independent directors meet with their fund CCO in executive session at every regularly scheduled board meeting. Items that may be addressed in board meetings with the CCO include: compliance matters, the CCO’s staffing and support, the CCO’s relationship with the adviser’s management, and confirmation that the CCO has not been subject to undue influence. In addition, many boards, sometimes through a specifically designated liaison such as the independent chair, communicate with the CCO between board meetings.

Under the fund compliance program rule, the board must approve the CCO’s compensation. The appropriate level of compensation will likely depend on a number of factors, including his or her experience, the responsibilities associated with the position, and the nature of the fund complex. The form and source of the compensation will vary across fund complexes. For example, some CCOs may receive a bonus in the form of stock options or restricted stock, which raises the issue of whether a fund CCO can have a financial interest in the adviser or its parent and still retain his or her independence.

Another decision faced by fund boards is whether any or all of the CCO’s compensation should be paid by the fund, reasoning that one way to ensure the CCO’s allegiance and a clearly delineated reporting relationship is for the fund to pay at least a portion of the CCO’s compensation. Boards may reasonably differ on their approaches to these issues, and should make a reasoned and informed decision based on the relevant facts and circumstances.

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