Service Provider Risk Evaluation Scorecard: A CCO's Tool - January 2007 Print E-mail
Written by Katie S. Kloster, CCO and Jeffrey P. Pruitt, Senior Compliance Analyst, Thrivent Mutual Funds   

The purpose of this article is to share an approach to evaluate the effectiveness of third party service provider operations and compliance programs. The law and the supporting regulations state that a Fund Board must take responsibility for the policies and procedures of each of its service providers. These usually include any sub-adviser, transfer agent, custodian, fund accountant or pricing service. In turn the Board looks to the Chief Compliance Officer (CCO), who provides the board with an annual written report about each of its service providers.

The report must address, at a minimum: (1) the operation of policies and procedures of the fund and each service provider since the last report, (2) any material changes to the policies and procedures since the last report, (3) any recommendations for material changes to the policies and procedures as a result of the annual review, and (4) any material compliance matters since the date of the last report.

The Service Provider Risk Rating Scorecard

The Thrivent Mutual Fund Scorecard highlights the important aspects of each of the service provider compliance and operational programs. The concise one page overview allows the CCO, fund management and the Board of Directors to quickly identify their compliance status.

 

 Firm Type/Name
Subadviser
"A"
Custodian
Transfer
Agent
Fund
Accountant
Pricing
Service
 Last COO On-Site Visit Date
11/01/2006
06/13/2006
08/13/2006
09/10/2006
04/13/2006
 Firm's Regulatory Standing - 30%          
 Disclipinary Information          
 Material Issues          
 Lawsuits and Enforcement Actions          
 Recent Exams          
 Compliance Program - 25%          
 Internal Controls          
 Reliable Processes          
 Accurate Systems          
 Trustworthy People          
 Compliance - Reportable Events - 20%          
 Prospectus & SAI          
 Mutual Fund Investment Polocies & Procedures          
 Adviser Investment Policies & Procedures          
 Demonstable Code of Ethics          
 Trading Errors - 15%          
 Trade Errors          
 Trade Revisions          
 Relationship - 10%          
 Tone / Timeliness Response          
 Overall Assessment
Compliant
Plus
On Watch
Compliant
Reportable
With Warning
Reportable
With Action

 

The scorecard captures key elements within a few major categories that are vital to a successful compliance service provider oversight program. The precise attribute for each category of scoring has to be tailored to the specific service provider. Each scoring category is assigned a percentage weighing. Our scoreboard is based on a five point rating scale: compliant plus, compliant, on watch, reportable with warning, and reportable with action. We fill in each attribute shown above for each service provider with a 1 to 5 scale.

The five point rating scale is defined as follows: compliant plus represents a strong program with adequate controls, no violations and demonstrates industry best practices; compliant represents a strong program with adequate controls and no material violations; on watch represents lack of controls within the program and or has at least one material violation or potentially serious pending legal or regulatory issue; reportable with warning represents lack of controls within the program along with material violations and known legal or regulatory settlement; reportable with action represents significant lack of controls within the program leading to regulatory scrutiny and possible censure of fines and material violations involving senior levels of management.

Service Provider Oversight Tools

Once the initial scoring has been completed, the ongoing monitoring process begins for each relationship. Obviously any degradation in rating has to be particularly carefully monitored and corrective action followed.

Conference calls should be held with compliance staff at each service provider to facilitate regular updates on compliance exceptions and changes to compliance procedures. We also conduct on-site visits that include key personnel interviews, compliance/operation department tours and reporting system demonstrations. The on-site visit is one of the most important parts of assessing each service provider.

Due Diligence Questionnaire

To conduct an effective on-site visit, we developed a Due Diligence Questionnaire. The questionnaire focuses on compliance program fundamentals and industry hot topics such as soft dollar use, exception reporting, code of ethics, trading system and compliance resources.

The completion of the questionnaire provides key elements, documentation and evidence that are vital to a successful compliance service provider oversight program. The questionnaire contains detailed questions that are created for the scorecard categories and customized for each service provider based on their function.

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Oversight of third party service providers has proved to be a difficult task for boards and CCO's. This issue can be minimized by implementing a risk rating scorecard which highlights and rates each important aspect of a service provider's compliance program in easy to understand terms to a variety of audiences.

 
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