More On Legal & Compliancefrom The Advisor's Professional Library
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
- Disaster Recovery Plans and Succession Planning RIAs owe a fiduciary duty to clients to prepare for disasters and other contingencies. If an RIA does not have a disaster recovery plan, clients financial well-being may be jeopardized. RIAs should also engage in succession planning, ensuring a smooth transaction if an owner or principal leaves.
The scope of the regulatory examination process continues to become more complex.
For investment advisors registered with the Securities and Exchange Commission, the frequency and scope of compliance inspections is, for the most part, determined by the Commission’s perception of advisors’ compliance risk profile. Examiners will focus on issues that represent the greatest potential threat to investors, and the corresponding frequency of examinations will be based upon the scope of the advisor’s operations and the results of previous exams. In order to be prepared, the firm should be familiar with both the examination process and the issues that will be raised during the examination.
The SEC has been doing an increasingly good job assessing initial advisory firm risk via its “limited scope” examination. The limited scope exam is a “mini” exam generally intended for newer registrants, but has also been used for firms that have not been examined for a substantial period of time. The primary objective of the limited scope exam is for the SEC to assess a firm’s level of risk and correspondingly determine when a full examination of the advisory firm should be conducted.
Most advisors tend to think about risk in terms of investments and portfolio management. However, the SEC also requires that advisors assess risk relative to operational and compliance risks. We advise investment advisory firms to perform an annual risk assessment as part of their annual CCO review, each of which should be provided to the SEC during a regulatory examination.
Depending upon the SEC branch office, the limited scope exam generally consists of between 10 and 12 requests for information or documents. The routine documents requested are the firm’s most current Parts 2A and 2B, financial statements, standard advisory agreements, an organization chart and employee list.
Questions asked during the limited scope exam that directly bear on the level of the firm’s risk include:
- Does the firm sponsor or manage any private investment funds?
- Does the firm have custody (i.e., trustee service, check writing, full POA, SLOAs, etc.), and, if yes, has it undergone (or contracted to undergo) a surprise CPA examination?
- Has the firm updated its policies and procedures to reflect substantive regulatory changes resulting from Dodd-Frank?
- Do the firm’s marketing materials meet or violate regulatory requirements (e.g., performance composite without appropriate regulatory disclosures or use of testimonials, direct or indirect, attributing favorable statements about the firm to the firm’s clients)?
- Does the firm errantly state its assets under management? Remember, “assets under management” is a defined term on Part 1 of Form ADV, and the firm should not reflect on either Part 1 or in any of its marketing materials that is has assets under management that do not meet the Part 1 definition.
Firms will also be asked to provide a copy of their most recent annual CCO review.
If the firm can adequately demonstrate its risk level to the SEC (especially if it is a low-risk firm), it can most likely forestall a full examination for a number of years. By conducting a mock examination, advisors are better able to address and correct current deficiencies, enhance current procedures and, most importantly, recognize and avoid those issues that could result in potentially adverse regulatory determinations or enforcement matters. 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 same.