From the February 2011 issue of Investment Advisor • Subscribe!

2011 Compliance Checklist

Ten compliance issues registered advisory firms must consider in the new year

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from The Advisor's Professional Library
  • Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
  • Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firm’s policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.

1. Has the firm determined whether or not it has custody as defined under amended Rule 206(4)-2? I suspect that many firms have not. I appreciate that the amended rule is very confusing, and that additional SEC guidance needs to be forthcoming, but it is not too late to comply—tardy compliance is better than non-compliance.

2. Is the firm prepared to finalize and file its new written disclosure statement on new Form 2A by March 31? My strong recommendation is for firms who have not previously sought experienced assistance to do so. Clear and concise disclosure of any actual or potential conflicts of interest must be provided.

3. Has the firm updated its policies and procedures to reflect regulatory changes, including custody, new written disclosure statement, political contributions and other Dodd-Frank issues?

4. Do the firm’s policies and procedures reflect the firm’s operations or have they been purchased from a “one size fits none” consulting firm? If the latter, the firm must review and revise to reflect the firm’s business practices. That is not to say that the firm should not engage or disengage such providers, but only that it requires some additional review to ensure they reflect the firm’s practices.

5. Is the firm adequately prepared for a regulatory exam? The scope of the regulatory examination process continues to become increasingly more complex. However, if the firm is adequately prepared to answer all of the issues that will be raised by the SEC during the examination process, the exam should not at all be a painful or worrisome experience! As I write, I am on a plane to the southeastern part of the country to prepare a firm for an exam. Please continue to be mindful that issues uncovered during mock exams conducted by non-law firms are discoverable by regulators and plaintiff’s lawyers, especially any written reports regarding the same.

6. Has the firm continued to reconfirm client investment objectives on an ongoing basis? Does the firm use an Investment Policy Statement? If so, has it been updated to reflect any changes? Correspondingly, does the firm use a “canned” initial client questionnaire? Questions such as how much of a market decline you could afford or tolerate should be reconsidered. Why? Because most advisors never go back and review such statements subsequent to the client engagement. Clients never respond by indicating that they can withstand or tolerate large fluctuations or losses—most firms greatly exceeded those parameters during the 2008-2009 correction.

7. Does the firm have clients who may outlive their funds? If yes, what has the firm done to both alert the client and protect itself from potential liability? Although a very sensitive issue, it is one that needs to be squarely addressed and documented.

8. Do the firm’s marketing materials promise too much? Not everyone will receive the same services! Avoid superlatives such as “comprehensive.” Have your marketing materials reviewed from both a compliance and liability perspective. Make sure that appropriate disclosures are provided.

9. Has the firm reviewed and updated its advisory agreements? Do they adequately reflect the firm’s practices? Generally, one size cannot fit all client engagements, especially if the firm’s client base or service offerings are diverse (e.g., financial planning, discretionary vs. non-discretionary investment management, participant directed retirement plan consulting, tax preparation).

10. Has the firm reviewed its E&O policy? Are the coverages still adequate given changes in the firm’s practices, service offerings and asset levels? Too many firms are under a false sense of security that the policy covers all of its activities. Read the exclusions! Obtain a policy rider or endorsement if necessary to fully protect the firm.

Remember, compliance is not difficult if you understand the rules and how they apply (and more importantly, do not apply) to the firm. Make 2011 the year that you undertake a real review of the adequacy of your compliance processes, disclosure statement, advisory agreements and preparedness for a regulatory examination. If you do so correctly, it will pay dividends.    

Thomas D. Giachetti is chairman of the Securities Practice Group of Stark & Stark, a law firm with offices in Princeton, New York, and Philadelphia that represents investment advisors, financial planners, BDs, CPA firms, registered reps, and investment companies, and a regular contributor to Investment Advisor. He can be reached at tgiachetti@stark-stark.com.

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