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Monday, February 10, 2014

Are Your Fund's Windows Broken?
Guest Column by: Jennifer Connelly

The SEC has recently embarked on a mission to focus on "broken windows," honing in on not just large federal securities violations, but small ones as well. The idea, as articulated by SEC Chairperson Mary Jo White, is to recognize that "the smallest infractions are very often just the first step toward bigger ones down the road," a strategy that takes a cue from then Mayor Rudy Giuliani and his famous campaign to clean up crime in New York in the 1990s.

White's public comments leave doubt as to the range of potential offenses that mutual fund firms may commit, but she did give some examples of areas the Commission will target. They include "control failures," and violations of rules that don't require proof of intent.

The "broken windows" theory is that if a window is broken and then fixed, it sends a message that disorder will not be tolerated. If the problem is not fixed, however, the message becomes that no one in the community cares, and that breaking more windows will not have consequences.

The SEC is applying this theory to securities laws -- that is, minor violations, that if ignored, can lead to bigger problems, and create a culture where laws are not respected.

Fund firm leaders are painfully aware of the damage to their firm's reputations that high profile cases brought by the SEC and other authorities involving violations such as insider trading or large-scale fraud can cause.

Yet smaller infractions and deficiencies can also tarnish a firm's image, and chip away at an otherwise blemish-free reputation. Those minor slip-ups can suggest - rightly or wrongly - that a larger, more fundamental problem is lurking behind the scenes.

Depending on which "window" is broken, and how it broke, fund firms may need to build a strong offense and a coordinated defense, which could involve responding publicly with the goal of reinforcing a resilient brand. This should be done with the full awareness that an enforcement action could be the consequence.

Evaluating problems early on and taking proactive steps to prevent them are keys to ensuring that those little problems don't grow into bigger problems. This means that fund firms should get ahead of problems, and resolve them honestly and transparently. While a slap on the wrist from a regulator - with a potential fine - is one setback, having to respond to investors whose trust in the firm's competence has eroded is another.

Investors are much more likely to be forgiving about a small misstep if the firm has been upfront about its mistake, has disclosed it, and demonstrated how it was resolved.

It is unclear whether the SEC has the capacity to aggressively go after small violations while still dedicating resources to offenses that cause widespread, pervasive harm to investors. But it is clear that when it comes to the "broken window" offenses, harm to retail investors in particular, will be on the radar. It's also clear that uncovering small problems often leads to the discovery of bigger ones. So while fund firms should obviously continue to prioritize potential problems that inflict serious investor harm, they should not forget to take steps to patch up the little ones too. 

Jennifer Connelly is founder and CEO of JCPR, a leading independent fully-integrated communications and public relations agency with practice groups in Finance, Technology, Commercial Real Estate, Professional Services, Health and Wellness and Innovation and Leadership.

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