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C C O P L AY B O O K
2015
CCO PLAYBOOK
Table of Contents
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For updates on compliance and associated steps the CCO can take,
please visit our blog at http://www.financial-tracking.com/blog/
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This budget request focuses on addressing these resource challenges by increasing funding
in the following areas:
Expanding oversight of investment advisers and strengthening compliance;
Bolstering enforcement;
Leveraging technology;
Building oversight of market infrastructure derivatives and clearing agencies;
Supporting implementation of the JOBS Act and enhancing reviews of corporate
disclosures;
Focusing on economic and risk analysis to support to support rulemaking and
oversight; and
Enhancing training and development of SEC staff.
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Adapted from What the CEO Wants You to KnowHow Your Company Really Works by Ram Charan, 2001.
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Return on Assets
You might think that making money simply means making a profit-buying low and selling
high. But theres more. Regardless of the size or kind of business, youre using your own
or someone elses money to grow. You borrow from a bank or use your savings. That money
represents your investment, or your investment capital. If you inherit the business, the
investment is given to you. Your investment then takes one form or another, whether it be
products (inventory), a small store and some shelving (plant and equipment), or an IOU from a
customer who took something home (accounts receivable).
The things youve invested in are assets.
Making Margin Meaningful
The term margin refers to net profit margin after taxes. That is, the money the company earns
after paying all its expenses, interest payments, and taxes. These expenses include all the
costs associated with making and selling the product as well as running the business, making
interest payments on any loans, and paying income taxes.
Gross margin, from which net profit margin is derived, is also critical to understanding the
fundamental anatomy of the business. Gross margin is calculated by taking the total sales for
the company or a product line and subtracting the costs directly associated with making or
buying the product or service.
Many businesspeople and investors track gross margin because it provides clues about
important changes that are affecting the nature of the business.
Making Velocity Meaningful
Many people focus on profit margin, but they overlook velocity. Heres what makes successful
CEOs different from many other executives: They think about both margin and velocity. This
dual focus is the centerpiece of business acumen.
Velocity is important to every company.
As you hone your business skills, think hard about return on assets and its basic ingredients
of velocity and profit margin. Look at your own companys return on assets. If you dont think
its adequate, press for ways to improve it. Even if you dont have all the answers, you can
help by asking the right questions: How does your companys return on assets compare with
the best in the industry? Over the past few years, has it been improving or declining? What
companies in any industry have the highest margins, the highest velocity, or the highest return
on assets? What can you learn from them?
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One truth about business is that the return on assets has to be greater than the cost of
using your own and other peoples (bankers and shareholders) money, the cost of capital.
If the return on assets does not exceed the cost of capital (which is typically 10 percent or
more), there will be real discontent among the investors because management is destroying
shareholder wealth. Some companies have businesses, divisions, or product lines that do not
earn the cost of capital. They therefore have to either improve the return or get rid of these
lines of business. Thats how many CEOs or business unit executives make the decision to sell
(divest) a business or discontinue a product line. Jack Welch used this principle at GE in the
early 1980s when he said that any business within GE that could not be number one or two
in its industry and did not earn the appropriate return on shareholder investment had to be
either fixed or sold.
Even if you dont know your companys cost of capital, you can make a difference by
suggesting ways to improve the return. If, for example, you work for an automobile company,
you might find that the return, on small cars is problematic. Auto manufacturers around the
world have in fact been earning less than 2 percent return on their automotive assets on
small cars, which is less than the cost of capital. How might that part of the business generate
a higher return? Think about both parts of return on assets: margin and velocity.
Growth
Growth is vital to prosperity. Every person, every company, and every national economy must
grow. Are you working for a company that is growing? Is it growing profitably and with no
decline in velocity? What happens when the growth rate is low or even negative?
If the company as a whole or your business unit lags behind competitors, your personal
progress will suffer. If the companys sales are flat for five or six years, people will not have the
opportunity to be promoted and move forward. Top managers will begin to cut costs, cut the
number of employees, cut layers. Theyll start reining in R&D and advertising, good people will
leave, and eventually the company will go into a death spiral. People will suffer.
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Customers
The street vendor knows his customers well. Simply by watching them, he can detect whether
they like his fruit or are growing dissatisfied, and whether their preferences are changing.
CEOs with business acumen have the same close connection with customers and strong
conviction that the business cannot thrive without satisfying them. Its universal.
Although many companies use scientific research methods like surveys and focus groups
to try to understand consumer needs, the best CEOs dont rely on clinical data alone. They
know that if they become removed from the action, they may miss important changes and
opportunities in the marketplace. Many of them make special efforts to observe and talk
directly with the people who use their products and services. Without customers trust, the
rest doesnt matter.
As you think about consumers, keep it simple. How can you describe what consumers
are buying? It might not be the physical product alone. Maybe theyre buying reliability,
convenience, or service. For many businesses and for the street vendor, what consumers are
buying includes trustworthiness. Many businesses run into trouble because the leaders lose
touch with consumers.
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Section 32
Authorizes the SEC to impose fines on individuals who willfully violate securities laws
or regulations.
Investment Advisors Act
Section 203(e) creates failure to supervise liability using similar language to
Exchange Act 15(b)(4)(E), with a similar safe harbor.
Section 203(i)(iv) authorizes the SEC to impose fines on individuals who fail
reasonably to supervise within the meaning of 203(e).
Section 203(k) gives the SEC the authority to issue cease-and-desist orders, with
language similar to Exchange Act 21C.
Rule 206(4)-7, 17 C.F.R. 206(4)-7, requires investment advisers to implement written
policies and procedures and to designate a CCO. In its discussion of the rule, the
SEC observed that the title of CCO does not, in and of itself, carry supervisory
responsibilities. 68 Fed. Reg. 74720.
FINRA Rules
Rule 3010
Requires member firms establish and maintain a system to supervise the activities
of each registered representative, registered principal, and other associated person
that is reasonably designed to achieve compliance with applicable securities laws
and regulations.
Establishes detailed requirements for the system that member firms must have in
place.
Rule 3130
Requires all members to designate and identify a chief compliance officer.
Requires the chief executive officer, or equivalent, to meet with the chief compliance
officer each year, and certify that the member has compliance processes in place
that meet certain requirements.
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Rule 8310
Authorizes FINRA to impose sanctions, including fines, suspension or revocation of
registration, and cease and desist orders, on firms or individuals.
The SEC reviews FINRA sanctions under 19(d) and (e) of the Exchange Act.
Other Rules
Commodity Futures Trading Commission (CFTC) regulations require diligent
supervision. See 17 C.F.R. 166.3.
Banking regulators, including the Federal Reserve and the Office of the Comptroller
the Currency (OCC), have enforcement powers under the FDIC Act, e.g.
The power to issue cease-and-desist orders against individuals or institutions
who engage or are about to engage in violations of law or in unsafe and
unsound practices. FDIC Act, 12 U.S.C. 1818 (b).
The power to remove individuals from office or prohibit them from the industry
when they, directly or indirectly. Engage in certain types of misconduct. FDIC
Act, 12 U.S.C. 1818 (e).
The power to seek monetary penalties. FDIC Act, 12 U.S.C. 1818 (i).
Dual Registrant Issues
Inconsistencies between the two regulatory regimes. For example:
Custody
Prompt forwarding of assets
OBAs
Personal securities transactions
Recordkeeping
Heightened Risks for Dual Registrants
Conflicts of interest, in general
Best Execution
In the Matter of A.R. Schmeidler & Co., Inc. SEC Exchange Act Rel. No. 70089
(July 31, 2013)
In the Matter of Goelzer Investment Management, Inc. and Gregory W. Goelzer,
SEC Exchange Act Rel. No. 70083 (July 31, 2013)
In the Matter of mandarin Investment Counsel, Ltd., et al., SEC Exchange Act.
Release No. 70595 (October 2, 2013)
Supervision separate from compliance
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So . . .
Here are Some Preventative Steps that CCOs/GCs Can Take to Avoid Liability
1) Clear & concise procedures addressing reporting lines and responsibilities.
2) If you are overwhelmed by to many responsibilities, this situation must be corrected
(being too busy to do the job is not an adequate defense).
3) Tailored procedures: Remotely located financial advisors pose a significant
compliance challenge.
4) Ongoing training in areas for which you are responsible is a must.
5) If you are involved in an internal investigation, be sure the investigation is thorough
and appropriate action is taken. Consider outside assistance and, while documenting
certain actions is appropriate and can be a defense to potential allegations, there are
caveats
6) Delegation of tasks Be sure to follow up.
7) Escalate unresolved compliance issues; ensure clarity as to who is the decision
maker.
Situations that Have Resulted in CCO/GC Liability
1) Participation in the Wrongful Conduct.
2) Failure to Respond Adequately when confronted with red flag warning signals of
misconduct.
3) Failure to Establish, Maintain, and Enforce Compliance Policies and Procedures.
4) Failure to Properly Delegate Compliance Functions
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Compliance, and now risk, are taking on higher profiles in all firms. Global financial
conditions and eroding market structures are putting enormous pressure on profit
margins. The time has never been better for the C-Suite to review an analysis of potential
cost savings, noting that such a strategic decision could immediately enhance profits,
reduce risks and control costs for the long term and help firms exceed regulatory exam
and client due diligence efforts.
2. Notable Findings from the 2014 Investment Management Survey sponsored by ACA
Compliance, Investment Advisor Association and Old Mutual Asset Management
75% of respondents consider cyber security/data security/privacy to be a hot
compliance topic.
Despite claims that advisers widely rely too heavily on third parties for
recommendations on proxy voting decisions only 33% of advisers reported using
third parties for this purpose at all.
75% of firms indicated that their compliance testing has detected issues, none of
which was deemed to be material.
Of the firms responding that they detected material compliance issues, 33% indicated
that the issues were in the area of personal trading/code of ethics.
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The survey found that while the majority of financial service organizations say they value
compliance, few compliance professionals believe their firms are managing the burden
well.
A common finding was that firms are understaffing and underfinancing the compliance
function.
58% of asset managers state that they need to focus more resources on compliance.
Similarly, 83% of broker/dealers feel they need more resources to manage compliance
efforts. On average, 74% of those tasked with compliance duties believe their firms
should commit more resources to the compliance function.
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Suggestion: Make changes to the environment and sequencing of work to break outdated,
unwanted patterns of behavior. Remove the temptation (perhaps an improperly used tool
or always-on website), rather than keep asking the employee to break bad habits.
2. She misunderstands the nature and scope of her work. Sadly, instead of asking questions
or signaling her confusion, she muddles through each day. Though her focus should be
on figuring out how to accomplish specific goals, co-workers and vendors dictate her
priorities.
Suggestion: Clarify your expectations for her position, updating and refining her job
description as needed. Coach her on techniques for dealing with outside pressures.
Confirm that you will provide direction and support but make sure that she develops the
ability to stand on her own without your continual intervention.
Suggestion: Establish firm lead times that are nonnegotiable, especially if certain
ideas require execution by work areas with limited resources. Alternatively y, establish
processes to execute quick turnaround on ideas with high ROI potential outside of your
regular workflow.
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4. She lacks discernment and is unable to sort through whats important and whats
insignificant. Overloaded with information and short on insights, she waffles on decisions,
defers action until she gets more clarity, and chooses unwisely.
Suggestion: Provide regular coaching sessions to step her through the process of making
sound decisions consistent with your companys mission and its values. Communicate
direction and get involved in helping her make difficult choices early rather than later.
5. He is not getting the information he needs. System glitches and ill-designed reports
prevent him from getting alerts, exception reports and so on in a timely manner. The
information that he does receive takes hours to analyze in order to get relevant facts
needed to do his job.
Suggestion: Dont underestimate the need for timely, accurate information. Make sure
your technology team solves these information problems quickly. While waiting for a
strategic IT solution, develop a workaround that speeds up the reporting process.
6. She doesnt trust your judgment. Specifically, she believes that your guidelines are
inappropriate based on her perception of customer needs and companys brand
positioning. So she ignores your instructions and continually does things her way, which
she believes provides a superior experience to the customer and upholds the brand
message more appropriately.
Suggestion: Clarify her sphere of influence and reiterate your brand promise distinct
from her desires. Plus, give her honest, quantitative feedback on her effectiveness.
Set objective, quantitative goals that measure her performance objectively, rather than
allowing her to rely a general feeling that she is a doing a good job, serving the customer
well, and preserving the integrity of the brand promise.
7. His workload is overwhelming. Because he feels that that he cant possibly complete all of
his work, he tends to focus on tasks that he enjoys and finishes assignments that benefit
the most demanding (rather than the most important) customers. Other items are left to
languish, eventually causing problems.
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8. Its complicated. The assignment is so out of the ordinary and complex that she doesnt
know w here to begin, so she delays the start. Plus, her regular workload keeps her so
busy that there is little time to really consider how to tackle this project.
Suggestion: Move mundane tasks to another employee so that she can have time to
develop the project plan. Encourage her to ask questions so that you can s hare your
knowledge, point to resources, and help narrow decisions.
9. The wrong person is in the job. You discover that he doesnt have the problem-solving
abilities, mental courage or leadership abilities that you thought he did w hen you hired
him. He doesnt really understand how to bring innovation to the company, which you
need now more than ever.
Suggestion: Realize that not all problem s can be remedied by changes in your approach.
Instead of struggling with a difficult person who is slow to adapt to new circumstances,
can t sort through workload without hand-holding, and the like, change the assignments
of your staff members or find a replacement who can do what he is supposed to do.
For updates on compliance and associated steps the CCO can take,
please visit our blog at http://www.financial-tracking.com/blog/
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