Erwin Schrödinger created the thought experiment that took his name, Schrodinger’s cat. Schrödinger stated that if you place a cat and something that could kill the cat (a radioactive atom) in a box and sealed it, you would not know if the cat was dead or alive until you opened the box, so that until the box was opened, the cat was both "dead and alive".
I’m not going to pretend to understand the “both dead and alive” part of this experiment but it’s clear the only way to determine if the cat is dead or alive is to open the box.
If we run Schrödinger’s experiment for your Investment Compliance program and then add some radioactive atoms in the form of what your firm claims it does in its Form ADV Part 2A, what are we going to find when we open the box?
Here are some common claims in Form ADV Part 2A that might sound familiar:
“The investment advisor seeks to ensure that its client receive best overall execution...”
“The investment advisor has a duty to conduct initial and ongoing due diligence of the subadvisor...”
“The investment advisor has adopted written policies to address the fair allocation…”
“The investment advisor will disclose conflicts of interest …”
“The investment advisor has a duty to engage in the ongoing monitoring of employee activity…”
The CCO should review Form ADV Part 2A carefully to ensure that the disclosure accurately represents current practices.
If your firm is making these claims, you will need to demonstrate this to the SEC. In 2018, the SEC fined an Investment Advisor $400,000 for failing to perform adequate due diligence and monitoring of certain investments (Adm. Proc File No3-18884). Clients were told in the adviser’s Form ADV Part 2A that the firm conducted initial and ongoing due diligence and monitoring of repo counter parties. The firm’s procedures consisted of a checklist of documents to be obtained as initial due diligence. There was no further guidance on what to do with the information obtained in the checklist or evidence of monitoring. According to the SEC order, the investment advisor’s compliance program lacked sufficient resources and failed to design and implement certain policies and procedures.
For any CCO, this case highlights the risk that firms take by not implementing, following and documenting compliance policies and procedures. If you need guidance documenting your workflows or if you are considering switching your compliance monitoring system, IMP can help.
