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SEC Risk Alert - 5 Things Not to Do by Bettina Eckerle

SEC Risk Alert: 5 Things Not to Do, Advisers!

Earlier this year, the SEC’s Office  of Compliance Inspections and Examinations (OCIE) published a Risk Alert with the “five compliance topics most frequently identified in deficiency letters to SEC-registered investment advisers.” The sample consisted of 1,000 examinations performed during the past two years. The five topics involved violations of the Investment Advisers Act of 1940 in the following areas:

Rule 206(4)-7 (Compliance Rule)

Despite its basic nature, violations of the Compliance Rule continue to persist. It requires that an Investment Adviser:

  • adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules;
  • review, at least annually, the adequacy of its policies and procedures and the effectiveness of their implementation; and
  • designate an individual as the Chief Compliance Officer (CCO) responsible for administering the compliance policies and procedures that the adviser adapts.

The SEC noted the following typical deficiencies:

Compliance manuals are not tailored to the adviser’s business practices. One particular observation stood out (that I am trying to drive home with all my new IA clients): Examiners continue to see advisers utilize “off-the-shelf” compliance manuals that have not been tailored to the adviser’s individual business practices. In adopting the release for the rule, the SEC identified the following areas that should be included:

  • portfolio management processes, including the allocation of investment opportunities among clients and consistency of portfolios with clients’ investment objectives, disclosures, and regulatory restrictions;
  • trading practices, including satisfying the duty of best execution;
  • proprietary trading of the adviser and personal trading by employees;
  • accuracy of disclosures made to investors, clients and regulators;
  • safeguarding of client assets from conversion or misuse;
  • accuracy of books and records;
  • marketing advisory services, including the use of solicitors;
  • valuing client holdings and assessing fees;
  • protecting the privacy of client records and information; and
  • business continuity/recovery plans.

Annual reviews were not performed or did not address the adequacy of the adviser’s policies and procedures. Advisers did not conduct annual reviews of their compliance policies and procedures. Additionally, exam staff found advisers that conducted annual reviews but did not address the adequacy of their policies and procedures and the effectiveness of their implementation. They often also did not address problems identified in the reviews.

Advisers do not follow compliance policies and procedures. Examples included: 1) Advisers not performing certain internal reviews of their practices required by their compliance manual, and 2) Advisers not adhering to certain practices relating to marketing, expenses, or employee behavior as required by their compliance manual.

Compliance manuals are not current. Examples were compliance manuals with investment strategies that were no longer pursued or personnel no longer associated with the adviser as well as stale information about the firm.

Regulatory Filings

Advisers are required to comply with certain obligations to make accurate and timely filings with the SEC. The Risk Alert references Form ADV and Form PF filings under the Advisers Act, and Form D filings under Regulation D of the Securities Act of 1933. Typical examples of deficiencies with respect to adviser regulatory filing obligations were:

  • Inaccurate disclosures. As examples, the SEC cited inaccurate reporting of custody information, regulatory assets under management, disciplinary history, and types of clients and conflicts.
  • Late and inaccurate ADV, Form PF and Form D filings.

Custody Rule

The SEC considers the custody rule one of the most critical rules under the Advisers Act.

The Risk Alert lists the following typical examples of deficiencies:

  • Advisers did not recognize that they may have custody due to online access to client accounts. The SEC notes that an adviser’s online access to client accounts may meet the definition of custody when such access provides the adviser with the ability to withdraw funds and securities from the client accounts.
  • Advisers with custody obtained surprise examinations that did not meet the requirements of the Custody Rule. Exam staff observed that some advisers did not provide the independent public accountants performing surprise examinations with a complete list of accounts over which the adviser has custody, or otherwise provide information to accountants to permit the accountants to timely file accurate Form ADV-Es. Also, some surprise examinations were not conducted on a “surprise” basis—such as exams being conducted at the same time each year.
  • Advisers did not recognize that they may have custody as a result of authority over client accounts. Examples included advisers or their related persons having power of attorney; authorizing withdrawal of client cash or securities; serving as trustees of clients’ trusts; or serving as general partner, managing member, or a similar position to a pooled investment vehicle.

Code of Ethics Rule

Exam staff found the following issues with compliance with the Code of Ethics rule:

  • Access persons not identified. Examples included the failure to identify certain employees, partners, and directors, for purposes of reviewing personal securities transactions.
  • Code of ethics missing required information. Examples included the failure to specify requirements for the review and deadlines for submission of personal account holdings and transaction reports.
  • Late submission of transactions and holdings by access persons.
  • No description of code of ethics in Form ADVs.

Books and Records Rule

Exam staff noted the following typical examples of deficiencies relating to the rule:

  • Advisers did not maintain all required records. Examples included not maintaining all the books and records for trading, advisory agreements, and general ledgers.
  • Books and records were inaccurate or not updated. Examples included having errors in the books and records such as inaccurate fee schedules and client records or stale client lists.
  • Inconsistent record-keeping. Examples included advisers maintaining contradictory information in separate sets of records.

Advisers, clients—or not—I would urge you to do the following two things: read the entire risk alert (see the hyperlink above) and conduct a quick reality check. The deficiencies/weaknesses noted cover simple territory; it will not take long and I am sure you’ve got this.

Eckerle Law offers a highest-quality and cost-effective alternative to the traditional law firm model for a wide variety of transactional and regulatory matters serving all your business law needs. Our experienced attorneys also provide a full range of compliance services for investment advisers, offering compliance tools that are tailored to fit the ever-changing regulatory landscape as well as your business needs.

If your company would like to strengthen its business practices, please contact us today so we can leverage our experience to create real-life business and legal solutions to help your business thrive.