From the November 2013 issue of Investment Advisor • Subscribe!

Exam Update: Are You Ready for the SEC?

Exams of today are not the same as they were in the past. Make sure you know what the SEC expects of you when examiners come knocking

More On Legal & Compliance

from The Advisor's Professional Library
  • Nothing but the Best Execution Along with the many other fiduciary obligations owed by RIAs, firms owe a duty to seek best execution of clients’ transactions.  If they fail to do, RIAs violate Section 206 of the Investment Advisers Act.
  • U.S. Securities and Exchange Commission Information This information sheet contains general information about certain provisions of the Investment Advisers Act of 1940 and selected rules under the Adviser’s Act.  It also provides information about the resources available from the SEC to help advisors understand and comply with these laws and rules.

I have just finished two weeks of traveling the country speaking to advisors in various cities. The topic: What have regulators focused on during recent exams? This is no longer your typical examination. Regulators are getting into the weeds on issues that they never addressed or paid less attention to in the past. If you are not prepared, you will quickly learn that there may be a big disconnect between your compliance efforts and what successfully completing an examination will require. Compliance is not a bunch of files or electronic folders—it is knowing what the questions are and how to effectively prepare satisfactory responses. Allow me to summarize some key issues that I stress during my speaking engagements and on-site compliance reviews:

  • If you can’t provide written confirmation to the commission that you do something, then the commission’s position is “you don’t do it.”

  • Every advisor has conflicts—disclose them! Do not be afraid to use the words, in bold type, “conflict of interest” on your Part 2A. Invite the client or prospect to speak to the chief compliance officer if he or she has any questions regarding the conflict.

  • Custody is and will continue to be a seminal issue. Make sure you understand it. Compliance with the custody rule is critical, and material deficiencies will no longer be met with a slap on the wrist. Most important: trustee service and standing letter of authorization.

  • Non-GIPS-verified composite performance presentations: Do you really need them? They’ll certainly raise your risk level and cause the commission to spend a substantial amount of time confirming that your performance presentations are compliant with applicable rules and no-action letters. The vast majority of advisors who maintain such presentations really do not need to do so. If there is a compelling need to use these presentations, do so strictly during one-on-one presentations and only upon specific request. Maintain a list of all recipients. Most important: corroborating documentation, correct disclosures and net of fees.

  • If you engage sub-advisors, engage separate account managers or recommend clients do so, or purchase private investment funds, make sure you can demonstrate initial and ongoing due diligence as to each such manager or fund. If you include the assets as part of your AUM, make sure you can demonstrate how you are able to monitor and supervise the managers on an ongoing basis. If you do not have transparency (the ability to electronically continuously view the assets at the custodian to determine that they are where they are supposed to be and that they are being managed in the designated manner), you will have some explaining to do.

  • Are you maintaining appropriate procedures for client information security? Is new Regulation S-ID applicable to your firm? Have the entities or vendors (e.g., building management, cleaning staff, security, shredders, IT consultant) that have access to your premises or information executed confidentiality agreements? Have you conducted any background search or due diligence on such vendors? Have you adopted a procedure such that you avoid acting on fraudulent requests for wire transfers of client funds? Do you share your offices with a firm or individuals who are unrelated to your firm? If yes, have they executed a confidentiality agreement? Do they have unrestricted access to your offices? Have you established procedures to secure client information?

  • Are your documents up to date? Review and update if necessary your policies and procedures and business continuity plan (see “SEC Issues Risk Alert and Reminder: Continuity Plans and Reg S-ID,” Investment Advisor, October 2013). Nothing will demonstrate a lack of a strong compliance culture more than stale or outdated documents.

Please remember that compliance is an ongoing process. What worked during the last exam may have little relevance to the next one. Get and stay prepared!

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