More On Legal & Compliancefrom The Advisor's Professional Library
- The Need for Thorough and Effective Policies and Procedures Whethere an advisor is SEC or state-registered, RIAs must revise their policies and procedures to address significant compliance problems occurring during the year, changes in business arrangements, and regulatory developments.
- 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.
Tom Giachetti doesn’t mince words. After Nexus Consulting’s Tim Welsh introduced the “celebrity compliance attorney” at the first of a three-city Laserfiche and Junxure Compliance Workshop road show in November 2012, Giachetti spoke bluntly, broadly and specifically. His topic? How advisors can protect themselves now from regulators, including the issues on which the SEC and state regulators are focusing their compliance exam efforts.
If you’re wondering whether Giachetti, a frequent speaker at industry conferences (disclosure: Giachetti is the longtime Compliance Coach columnist for Investment Advisor), had anything new to offer, consider what Greg Friedman, president of both wealth management firm Private Ocean and advisor CRM firm Junxure, said in his follow-up presentation. “I just took two pages of notes” on what he heard from Giachetti, who happens to be Friedman’s compliance attorney.
First, the big picture. Giachetti said that over the past three years, the compliance world “has changed for advisors.” Specifically, “post-Madoff,” the SEC is focusing on two broad issues when it conducts audits of advisors: the underlying integrity of client assets and the underlying integrity of clients’ information. “Are the assets where they should be?” he asked, and said that advisors need to think about and document their processes, “especially if you use third-party managers.”
One reason why the examiners want to know where client assets are: there have been increased instances of wire fraud, Giachetti said, where a fraudster has stolen client funds using purloined email credentials from clients’ advisory accounts.
Giachetti’s second warning to advisors was about the present compliance danger. “We’re looking at a dangerous next 20 to 30 days; clients will be looking to get out” of many investments and the markets in general and move to all cash as the fiscal cliff nears, he said. Advisors should ensure that they have signed confirmations from clients stating that they want to move to cash instead of staying the course on their plans, since “clients love you until they don’t” and may well drag advisors into arbitration or court sometimes years down the road. Nutshelling the issue, Giachetti said “money management is easy; client management is difficult.”
In his own presentation, Friedman (further disclosure: Friedman is a regular blogger for AdvisorOne.com) concurred that “it’s not the SEC I’m afraid of, it’s ticked-off clients.”
Third, Giachetti said of the newly aggressive state regulators: “States are becoming adversarial; they are not your friends.” The states are being “very punitive now” in their exams of advisors, Giachetti said, particularly in areas like notice filings and IAR registration filings, “because they need the money.” States are especially focused on firms timely filing those investment advisor representative filings: “IARs must be registered in the state.” Moreover, he said the SEC has four current enforcement actions underway for SEC-registered RIA firms that “puffed up their assets” (including one against a New York-based firm with whom the SEC recently settled for its “aspirational AUM”).
Why that focus? “The SEC wants to push advisors to the states, which are bankrupt,” he argued. The states may be more aggressive, but he suggested they may not be more skilled than SEC examiners: “The states make the SEC look like Mensa members.”
The fourth warning is about your reported AUM and the SEC. “Assets under management is a defined term on Form ADV,” Giachetti counseled. “Don’t mess around with it.” In particular, he urged advisors never to use the term “assets under advisement.” The total might sound impressive to yourself and potential clients, but the SEC will want to know why you’re using such an ill-defined term.
Fifth, be specific on what you are offering your clients in the investing area. “Don’t use terms like ‘moderate’ or ‘aggressive’ in your investment policy statements” since, he said, doing so “could well come back to bite you in the ass.” Giachetti argued, “You don’t need a canned questionnaire” to assess a client’s risk tolerance. Instead, clearly define the client’s long-term and short-term goals, include a percentage of losses that the client can afford to lose and have the client sign that agreement.
Sixth, Dodd-Frank’s new requirements. Returning to his dictum that the “world has changed,” Giachetti listed several new requirements for advisors mandated by the Dodd-Frank Act: “You need a whistleblower policy, a pay-to-play policy and to be compliant with the revised custody rules.” In addition, he warned about the dangers of inflating the services that you offer cl
ients. “The scariest word on God’s green earth,” he said, is when he sees an advisory firm calling itself a “comprehensive planning firm.”
Seventh, don’t make these mistakes. Giachetti listed several steps that some firms take that might sound wise but are in fact very unwise. For instance, “don’t keep minutes of client meetings—they’re discoverable.” Moreover, the SEC has changed its exam question referring to client meeting minutes. Now, the question asks an advisor to offer the examiner “minutes to the extent that they are maintained,” so now they’re not required. Another move to avoid: having a low deductible on your E&O policy and failing to understand what your policy covers. To redress that, “read your policy and make sure it covers what you do in your practice,” then “raise your deductible and increase your coverage.” Covering a low deductible of $25,000 or $50,000 “won’t put you out of business,” but having a low amount of coverage—“low” being below $5 million—could easily do so.
Eighth, the DOL and FINRA for advisors. Giachetti reported several exam areas that at first glance might not seem appropriate for RIAs. For example, he said the Department of Labor is conducting ERISA exams of RIAs in New York and Los Angeles, and “they’re coming to Chicago.” Additionally, SEC examiners are now asking RIAs to explain how they supervise their branch offices, essentially “putting a FINRA question on an advisor exam.”
Ninth, your CCO. Giachetti had strong advice on the role of an RIA firm’s chief compliance officer. “CCOs better have authority in your firm” to ensure compliance well before an examiner comes to visit. CCOs with that authority, he said, “are the ones that will get you through an exam.”
(Giachetti explores the role of the CCO in more detail in his December 2012 Compliance Coach column for Investment Advisor.)
Tenth, since compliance is “all about getting you through” those exams, advisors should “take control of their businesses, making sure your CCOs have the resources they need.” He had special words of scorn for “consultants” who provide “one size fits none” compliance documents. Returning to his advice on reading your E&O policy, he suggested principals of RIA firms read all their documents to ensure that they accurately reflect the services and structure of the individual firm.
In his follow-up presentation, Friedman agreed that, “compliance is all about surviving audits.” Drawing on his experience of surviving five audits, he said advisors need to demonstrate a “culture of compliance” and that “you run a tight business.” Finally, he said that in preparing for an exam, make sure you use your technology, especially your CRM system, to quickly and more easily supply what examiners tell you they’re looking for, since “the CRM is where all this data lives,” including client lists, contact lists, important dates and account data. “Examiners don’t like to be buried in paper,” he said. “They prefer electronic.”