The Advisor's Professional Library

How to Avoid Sabotaging Your Compliance Exam

January 1, 2012

1 Free Preview Remaining

You have used 1 of 2 free previews from The Advisor's Professional Library

There is much more to compliance examination survival than knowing all of the rules. It helps to understand why the rules were put in place and recognize that examiners are not the enemy. Compliance examinations are necessary in ensuring all RIAs are playing by the same rules, which are designed to protect investors. Examinations can be a learning experience and provide opportunity for advisors to show examiners they are committed to complying with all of the rules impacting RIAs.

It was the comic strip character, Pogo, who said, “We have met the enemy and he is us.” Although the creator of that comic, Walt Kelly, was not talking about RIAs, the statement may also apply to advisory firms. Sometimes, RIAs are their own worst enemy during a compliance examination, therefore, it is imperative they avoid sabotaging the exam.

Having a bad attitude can make a bad situation worse for an advisor. While some examinations are routine, others are prompted by a tip or complaint, and defensive behavior could make examiners believe there is substance to the tip or complaint. Every member of the firm makes an impression on the examination team from the moment examiners walk through the door to the minute they pack up and head home.

Examinations Are not a Debate

On occasion, RIAs take a confrontational approach with examiners. Instead of being cooperative and helpful, an advisor might mistakenly debate compliance issues with examiners. Compliance examiners do not expect advisors to be argumentative and look unfavorably on this reaction.

Advisors sometimes argue that the last examiner did not point out a particular deficiency during a prior regulatory exam, so it should not be a problem now. Even though a problem was overlooked during a prior exam, this does not make the firm compliant with applicable rules and regulations. Similarly, if another advisory firm engages in the same prohibited conduct, this does not make the RIA compliant. For example, it is immaterial that another RIA’s website uses noncompliant content and does not follow the rules.

When IARs are abrasive in their dealings with examiners, the outcome of the exam will not be favorable. The examination may become adversarial, and examiners might dig more deeply than would otherwise be the case. Furthermore, when IARs are pushy or hostile in their dealings with regulators, examiners might wonder if they are equally aggressive with clients. If there are client complaints against the RIA or IARs, examiners will be much more inclined to believe them. In addition, examiners may be less likely to give the benefit of the doubt to the RIA.

Some IARs demonstrate a condescending attitude toward current and prospective clients, and examiners will be aware of this sentiment. After being criticized that his marketing materials won’t be understood by unsophisticated investors, one IAR defended himself by saying that these individuals will never understand the firm’s investment strategy. He argued that if they understood investing, there would be no need to hire an advisory firm.

Examiners will not validate that argument and expect IARs to make a good faith effort at explaining their strategies in terms a layperson can understand. Furthermore, examiners might infer that if an advisor is not explaining the firm’s strategies in plain English, it may not be disclosing the risks in a meaningful way, either.

Tips for Dealing with Examiners

Although advisors will never win a debate with examiners, RIAs can still come through an examination unscathed. The key is for an RIA to make a conscientious effort in fulfilling its fiduciary obligations and remain compliant. The following tips for interacting with examiners may also be helpful.

  • Empathy. If advisors appreciate why examinations take place, they will be more understanding of regulators who scour their books and records. Examiners’ mission is to protect investors, not to make an advisor’s life miserable.
  • Respect. Examiners should be treated with the respect they deserve. RIAs should see to it that examiners have a comfortable work space for conducting the examination. They should be given a comfortable office or conference room, not a tiny cubicle. Although it is important for RIAs to be cooperative and comply with all reasonable requests, examiners should not be permitted to have unrestricted access to all files. The firm’s CCO should be readily available throughout the examination and should be the liason between the RIA and examiners.
  • Courtesy. Being gracious to examiners does not mean offering examiners anything beyond coffee. An examiner with the Pennsylvania Securities Commission told the audience at a seminar on October 20, 2011, that he is not permitted to accept lunch from an RIA.
  • Cooperation. Whether an exam is scheduled in advance or comes as a surprise, employees should be made aware that examiners are or will be in the office. It should be stressed to them that examiners deserve their complete cooperation. Any request to interview employees should be funneled through the CCO. If the examination team asks for documents and client files, the CCO or a designated person should retrieve them. Employees need to be instructed in answering questions truthfully and patiently, and answer questions asked rather than volunteering information. Everyone at an advisory firm should avoid comments or body language implying that they can’t be bothered and examiners are interfering with their work.
  • Commitment. The firm’s CCO or head of compliance must be able to demonstrate that he or she is committed to compliance. The CCO must understand the Investment Advisers Act and all of the applicable rules. Examiners expect the firm’s CCO to reprimand the firm’s executive officers if they wish to violate compliance rules. The RIA’s commitment to compliance must be demonstrated by giving the CCO adequate resources and staffing, as examiners may look at the firm’s budget for adequate compliance. Examiners will compare the CCO’s compensation to other members of senior management.
  • Organization. Advisors send a positive message to examiners by being organized. When examiners request documents, RIAs must be able to locate and produce them within twenty-four hours. Policies and procedures should also be thorough and organized.

When an examination team walks into an office where files are in disarray, they will wonder if the RIA is diligently managing clients’ money. Examiners might also be concerned about clients’ privacy and security of their personal information.

The Big Picture

Even when RIAs make mistakes which are uncovered during compliance examinations, advisors can still make a good impression on examiners. The examination team should leave the office with the belief that every member of the RIA is committed to compliance. Investment advisors can validate that positive impression by promptly correcting any deficiencies found.

Too many RIAs are unwilling to admit compliance mistakes. It is far better for an RIA to put a memo to the file indicating it missed a compliance deadline instead of backdating a required document or report. Nevertheless, it is not enough for an RIA to simply apologize for a mistake. They must show what actions were taken to avoid future missteps. Usually, the proper course of action is to update the firm’s policies and procedures.

Les Abromovitz

Les Abromovitz

Les Abromovitz is the author of The Investment Advisor’s Compliance Guide, published by The National Underwriter Company/ALM Media.

An attorney and member of the Pennsylvania bar, Les has handled hundreds of consulting and publishing projects for National Compliance Services,, a leading compliance and regulatory services firm. He has conducted a number of seminars and training sessions dealing with compliance subjects. Les is also the author of several white papers that analyze compliance issues impacting Registered Investment Advisors (RIAs)‎.

To contact Mr. Abromovitz, email or call 561-330-7645 Ext. 213‎.