Cognolink Compliance Briefing Note - September 2012
Best Practices In Compliance For Expert Networks
The objective of this briefing is to discuss best practices for expert networks nearly two years on from the commencement of SEC actions against certain individuals associated with such networks.
In April 2011, in the immediate aftermath of the SEC’s initial investigations into insider dealing associated with expert networks, CognoLink published a briefing note discussing best practices for the expert network industry. 18 months on, we have reflected on the dozens of discussions we have had with client compliance teams and produced this briefing containing our view of current best practices in the industry.
The SEC insider dealing actions against certain individuals associated with expert networks had a significant impact, both on expert networks and the investment firms which use them. Over the last two years or so, most investment firms have carried out detailed due diligence on the expert networks they use, or are considering using, and have re-evaluated their compliance procedures.
Whilst this initially caused considerable disruption, the longer-term effects have been positive for all concerned. The SEC has not, as some first feared, banned the use of expert networks and the SEC’s public statements have made it clear that, in its view, their use is not, in itself, a bad thing. Standards in the industry have been raised generally and we have seen a number of smaller players, with inadequate compliance infrastructure, disappear from the market.
Most investment firms have concluded that, provided the expert network has clear and robust compliance procedures in place, they represent a safe way for their investment professionals to interact with industry experts in a transparent and auditable way.
Some of the key questions and issues which are addressed by compliance officers when looking at expert networks include:
Does the expert network have compliance procedures in place to ensure that any expert with whom the client consults has agreed to appropriate terms and conditions?
It is essential that the expert network has a formal contract in place with any expert with whom a client may consult, by which the expert commits to key compliance obligations. Such obligations should include warranties as to accuracy of the expert’s employment status and biographical information and undertakings not to disclose material non-public (or otherwise confidential) information or to breach any other obligations – whether contractual or under the general law. There must be clear evidence of the expert’s agreement to these terms.
The CognoLink Approach:All experts must accept CognoLink’s Terms and Conditions (without amendment) on joining our network and again prior to consulting on each client project. The Terms & Conditions, which contain extensive compliance obligations, can be viewed on CognoLink’s website: www.cognolink.com.
The Terms and Conditions are such that clients also have the benefit of the compliance related warranties and undertakings given by the expert.
Can the expert network obtain undertakings from the expert that he/she will not provide material non-public information and/or obtain responses to client specific questions or representations?
It is important for clients that they have the benefit of undertakings from the expert that they will not provide material non-public information. This is, without question, an essential requirement for all expert networks, although so far the only regulation in this regard is that issued by the Massachusetts Securities Division.
The CognoLink Approach:Since its inception, CognoLink has obtained such undertakings from its experts (in the Terms & Conditions referred to above). However, many of our clients (and the majority of US clients) require a representation of this kind in their own approved language. CognoLink’s bespoke IT system enables such statements to be automatically included within the project process, to ensure that no consultation takes place without the required undertakings having been obtained. The responses/confirmations are obtained by electronic “click through” acceptance and the expert’s responses are available for the client compliance team to view on CognoLink’s compliance extranet.
How does the expert network ensure that employed experts are permitted by their employer to consult?
Clients often ask this question. There is a perception that employed specialists raise greater compliance concerns than other types of specialist, particularly if their employer is a public company.
The CognoLink Approach:We typically rely on confirmations from the expert (in the Terms & Conditions) that they are not restricted by their employer from engaging in consultations with third parties. Our compliance tutorial also reminds experts that they must not be restricted by any contractual obligation from consulting, and, in particular, not restricted by their employment contract. It would of course be ideal if every employed expert had obtained a letter from their employer confirming their freedom to consult. However, for practical and timing reasons, such a situation is not achievable; not to mention the problems of being satisfied that the person who signs such consents in each case has the requisite authority.
If CognoLink is notified by a company, or otherwise becomes aware, that the company does not permit its employees to engage in outside consultations, that company is added to our “Do Not Contact” list and we will not: (a) seek to recruit experts employed by that company; or (b) propose experts currently employed by that company (already registered on our network) on client projects.
Does the expert network require experts to be trained in respect of their compliance obligations?
Whilst some are, not all experts are familiar with and understand their legal and regulatory obligations, particularly the significance of material non-public information in the financial markets. Investment firms require assurance that not only have experts accepted certain contractual compliance obligations, but that they also understand their significance.
The CognoLink Approach:CognoLink’s belief has always been that, in addition to accepting our Terms and Conditions, it is vital to try to ensure that the expert understands those obligations and, in particular, their significance in the context of discussions with our clients. Accordingly, all experts are required to complete our compulsory compliance tutorial on registering with our network and every 200 days thereafter. We retain records of the expert’s completion of the compliance tutorial and, if an expert’s compliance tutorial is not up to date, they cannot consult with a client. This is enforced by an automated IT block.
In addition to its standard procedures, can the expert network accommodate specific client compliance requirements?
Expert networks are likely to work with a diverse range of investment firm clients, as well as management and strategy consultancy clients, spread around the world and with differing investment strategies. Clients consequently have very different compliance requirements. It is important for clients that the expert networks which they use can accommodate their specific compliance requirements and operate them effectively, consistently and in an auditable manner.
The CognoLink Approach:Whilst CognoLink’s compliance framework and procedures are robust and represent best practices in the expert network industry, our standard procedures cannot, on their own, meet the diverse requirements of each and every client. CognoLink’s bespoke IT system is flexible and enables us to incorporate clients’ specific compliance requirements within our processes. We can include any specific client questions or required representations within the project acceptance process which experts must complete for each project. We can also accommodate client requirements to ensure that consultations do not take place without prior approval from CognoLink or client compliance. We use our experience to assist clients in implementing their compliance requirements in a way which fully satisfies those requirements but does not impair the usefulness of our services to their investment professionals.
What systems/procedures does the expert network have to enable compliance officers to regulate consultations with experts and to track/monitor consultations/projects?
Regardless of whether they are actively involved in approving each and every consultation which their analysts engage in, compliance officers must have the ability to monitor and track projects so that they are fully aware of what their analysts are working on and with which experts they have (or are proposing) to consult.
The CognoLink Approach:Our IT systems enable client compliance teams to have as much involvement in, and control over, the process as they wish. We operate a client extranet for compliance officers which enables them to view all current and past projects on which their investment teams are working. We can also copy compliance on relevant emails in the project process, e.g. profile submission, selection, contact detail submission, etc. Client compliance involvement can range from:
- Active: All consultations must be approved by client compliance team. Approval/refusal is usually given by using the “allow” and “block” buttons on the compliance extranet. Without approval being given, there is an IT block to prevent the specialist’s contact details being provided to the analyst.
- Passive: No specific approvals required, but compliance copied on certain emails and/or access to the client extranet to monitor projects.
- Intermediate: client compliance approval required in certain circumstances, e.g. specialist currently employed at a publicly listed company.
Does the expert network keep records of the various steps in the compliance process and can it demonstrate compliance with agreed procedures?
It is crucial for firms that use expert networks that those networks maintain an accurate and auditable record of consultations which have taken place between analysts and experts on the network. Further, it is not sufficient for expert networks to merely agree to operate certain compliance procedures. They must also be able to clearly demonstrate and provide evidence that they have in fact complied with those procedures for each and every consultation.
The CognoLink Approach:Our bespoke IT system keeps records (including exact dates and times) of the key compliance steps in the project process, including:
- project acceptance, i.e. the date the expert formally accepted the project, accepted our Terms and Conditions and also answered any client-specific questions
- compliance tutorial completion
- compliance approval – internal (i.e. by CognoLink compliance) and/or external (i.e. by client compliance)
- expert contact details submission
- consultation date and duration
CognoLink provides clients with regular usage reports showing the consultations which have occurred during the relevant period including: date, duration, analyst involved and specialist consulted. These reports are backed up by compliance reports which provide the information mentioned above for each specialist consultation.
Our approach is to be totally transparent with clients. We welcome being able to demonstrate to clients that we are operating the compliance processes which we have agreed to. In addition to providing usage and compliance reports, we are also happy to accommodate client requests for audits (whether “on paper” or in person).
In our opinion, the intense scrutiny to which expert networks have been subjected since the end of 2010 has had a positive effect on the industry. It has caused expert networks and their clients to examine and test the compliance procedures which they operate and has resulted in a raising of standards in the industry as a whole, including removing those networks with either insufficient commitment or resources to operate a robust compliance framework. CognoLink has been committed to the highest standards of compliance since it was established and this is embedded in our processes and culture.
If you would like more information about our compliance processes, or are interested in how we can incorporate your company’s specific compliance requirements, please contact our legal team at firstname.lastname@example.org. Alternatively, get in touch with your usual CognoLink contact, who will be happy to help.