Shock waves from the exposure of inherent weaknesses in the way investment funds are structured and operated are prompting financial services providers to take a closer look at the products they recommend to clients. Various regulators are reminding providers of the need to perform a reasonable level of due diligence, and to be sure they have a complete understanding of the products they are selling, and of the suitability of the products for clients.

In this environment, the provision of “due diligence” and “compliance” services has become a growth industry. This was evident by the number of vendors at this year’s Investment Funds Institute of Canada’s annual conference who were offering various types of compliance-oriented systems to the industry.

There is grumbling about the current focus on due diligence and compliance — the high costs, delays and imperfect results. The situation is not helped by the absence of inherent governance requirements for how investment funds are structured and operated. In the absence of these standards, financial services providers are finding that much deeper inquiries, analysis and risk assessment are required to determine suitability of the investment products for their clients. This is provoking surprise about the lack of standards, and complaints that the burden of this deficiency is falling on financial services providers rather than on regulators.

The debate about on whom the burden should fall, and whether regulators or financial service providers should be responsible for ensuring a “good housekeeping” seal of approval before an investment fund is offered to investors, is a provocative one.

Regardless of which side of the debate you are on, the reality is that there is an urgent need to take a closer look at the various fund managers, who they are, what their experience is, how they operate, what their business risks are and what governance and operating systems, procedures, controls and internal reporting mechanisms they have in place to manage their identified risks. For most people, this is like looking into a black box.

However, help is on the way from Ethidex Inc. — a Toronto-based firm that offers risk-management and compliance solutions to mutual fund managers. Ethidex has acquired and enhanced compliance office software originally developed by PricewaterhouseCoopers LLP. It has also acquired and updated the Compliance Manual for Mutual Fund Managers, originally developed by IFIC.

Michael Deck, one of the company’s managing directors, says Ethidex provides a tool box and framework for organizing, reporting on and centrally managing a compliance management system. The programs provide an “end-to-end” management system that is continually updated to reflect new or modified regulatory requirements. The software includes the capability to incorporate international regulatory requirements if they are applicable to specific business operations; the ability to incorporate additional control objectives, higher standards and corporate policies; and the ability to design specific controls to address identified business risks and to evaluate their effectiveness. The software can also be used to track and manage specific issues; to document complaints and their disposition; to track compliance with and sign-offs on corporate policy; and to provide training to employees and test their competencies.

Deck says the systems simplify the work of internal and external auditors, answering regulatory inquiries, reporting to directors and allowing directors to access the information they need to carry out their duties properly. He says directors of fund managers ought to require management to have a comprehensive, centrally manageable compliance monitoring system for their own protection and to satisfy their due diligence requirements.

He thinks independent review committees should look at having these processes in place as a means to document their procedures, controls and policies for evaluating conflicts, their receipt of conflicts reports and their resolution.

Deck’s observations make a lot of sense. They would go a long way toward addressing the needs of fund managers, financial services providers, regulators and investors. IE