Compliance and The Importance of Being Earnest

How to Create a Positive Culture of Compliance 

No longer the overriding societal value it once was in the Victorian era, earnestness is making its comeback in the most unlikely of places: hedge funds.

While always fervent in their pursuit of alpha, hedge funds have finally realized the importance of being earnest when it comes to pursuing compliance. And yet just like Wilde’s trivial comedy for serious people, it’s complicated.

Funds must tackle many moving parts, those parts often move in silos and, as most hedge fund Chief Compliance Officers (CCOs) will attest, it’s hard to be certain everyone has the complete and accurate picture they need, when they need it. In fact, when it comes to developing a culture of compliance, no-one’s entirely sure what that picture should look like at all.

What is a Culture of Compliance Anyway?

The SEC, FINRA and the CFTC all continue to hammer home the importance for registrants to develop a culture of compliance, and yet there’s no checklist, no hard and fast rules, no blueprint. In FINRA’s targeted exam letter from February, ‘Establishing, Communicating and implementing Cultural Values,’ it states:

”One definition of ‘firm culture’ is the set of explicit and implicit norms, practices and expected behaviors that influence how employees make and carry out decisions in the course of conducting the firm’s business. Your firm may have its own definition of ‘firm culture’ that it can use…”

Case in point.

While you’re always serious in intention, when terminology like ‘culture’ is your leading beacon in practice, and success could be considered largely ‘subjective’, it can all feel a bit trivial at times.

The only place to start is to channel those earnest CCO qualities of depth and firmness and commit to full transparency, show intent and give it serious attention. But how to make that earnestness permeate across an entire firm, and develop into a culture?

You’ve done all the groundwork: you’ve got your code of ethics down, your reporting is on point, you’re in a constant state or examination preparedness and now you just need to create some culture. This is where CCOs and fund managers often go wrong.

Where Most Hedge Funds Go Wrong with Compliance

One of the biggest mistakes hedge funds make when it comes to compliance is how it’s enforced.

Forcing compliance as a cultural norm may keep the regulators at bay in the short term, but over time it’s not good for business. In order to make compliance a positive part of your corporate culture that will stick, you must make it something that employees don’t resent.

More than just making compliance happen, a successful fund will work to instill a positive attitude toward compliance. And to create a positive culture of compliance takes time, resource and education.

Funds must avoid the pitfalls of focusing too heavily on why non-compliance is disastrous for business, and an employee’s responsibility within that. Instead, it’s important to also communicate and demonstrate why compliance can be good for business and good for personal goals.

A positive culture of compliance can be profitable. After all, investors now seek out funds with a demonstrably strong culture of compliance and will proactively avoid those without.

The funds that win out are those that make compliance understood and make it as frictionless as possible to achieve; remove barriers to compliant user activity, create incentive programmes for employees, proactively look to replace bad habits with genuinely beneficial alternatives that work for people as well as regulators.

Five steps for building a positive culture of compliance

Building a culture of compliance is not a new concept. But with the SEC’s broken windows policy and increased levels of enforcement it’s now more important than ever. It comes down to creating a strong and positive foundation for compliance right across the firm. To do so, funds should  always be looking to these five practices:

1. Employee buy-in – A top down approach is vital to compliance culture. Ensuring the right ‘tone at the top’ has been widely discussed (and can’t be overlooked) but its point is that everyone  understands the risks, the responsibility and the purpose. Everyone, that is, from boardroom to postroom requires training and education. Fund CCOs and management that proactively involve employees in how best to remove the barriers to compliance in their roles, to discuss compliant working practices and bring in relevant incentives, are those best placed to build firm-wide employee buy-in, and a positive attitude toward compliance that sticks.

2. Staying current – A culture is dynamic, always evolving. Your positive culture of compliance will require continuous improvement and constant attention. To ensure your policies and culture-building activities are not a static collection of tick boxes gathering dust on a shelf somewhere, stay current with regular assessments, improvements and proactive change management.

3. The right resource – The cost of maintaining compliance can be high, but it’s necessary. Ensuring adequate funding is allocated to compliance is a clear demonstration of your commitment in the pursuit of compliance. Like everything else though, this isn’t static – regulators may well expect to see resource increase alongside regulations and demand.

4. Thorough documentation – We all know that all regulatory bodies love documentation. You’re all over it when it comes to compliance programs, reporting and procedures, but don’t forget to do the same with your cultural efforts too – write it down, communicate it and prove it. Remain methodical and thorough (and up to date) in your documentation and you’ll be in far better position to be in that constant state of preparedness.

5. Effective technology – All technology in use across your fund should help mitigate compliance risk (and certainly not aggravate it). Effective internal controls and secure data management are vital to your compliance posture, while the right technology foundation can also reduce barriers to good employee compliance practices and support a positive working culture. For example, introducing automation can reduce human error in reporting, as well as removing the tiresome admin-based compliance tasks that frustrate employees and take-up valuable working time. At the same time, systems with built-in compliance features can enable CCOs to spend time on supporting people and processes, rather than collating reports and data – a positive for the regulators and for the business.

The technology powering your fund (your processes, your people’s productivity and your data) can have a significant impact on your compliance readiness, and instilling a positive compliance culture across all of these five areas. For more information on how effective technology can help turn compliance into a positive for hedge fund performance and productivity, go to our new hedge fund compliance page or take a scroll through our compliance blog.

Need more culture?

If you’re looking for some culture outside of the latest SEC advisory, or a little light relief from discovery requests and audits, The Importance of Being Earnest is a great play for that. A comedy of deception, mistaken identity and misadventure, you may be hard pushed to miss the not so subtle undertones of honesty and compliance that run throughout, but that makes it all the more enjoyable!

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It might even be a good opera, so this Royal Opera production at the Lincoln Centre in June may well be worth a look: http://lcgreatperformers.org/seasons/2015-16/the-importance-of-being-earnest-jun-02

(It may not be of course, so please do not take this as an informed recommendation.)