In this, my initial column, I will begin to address compliance and practice protection-related issues important to both SEC and state registered investment advisors. My intent is to inform RIAs on current and ever-changing regulatory requirements, prepare them for regulatory examinations, and to help them avoid adverse regulatory/client/employee events.
Investment Advisers Act Rule 206(4)-7 requires SEC RIAs to implement and maintain appropriate policies and procedures. Some states have correspondingly adopted the same requirement. Rule 206(4)-7 remains a central focus of SEC exams, which continue to grow more complex. A ripe area for SEC deficiencies is failure to have policies and procedures that appropriately reflect your business operations or failure to follow them.
This is particularly important because the SEC has replaced its five-year examination cycle with a risk-based program (to be the subject of my next column). As a result, SEC examiners are focusing on advisors and issues that represent the greatest potential threat to investors.
The one area that had caused the most confusion for advisors is electronic recording keeping and e-mail retention.
An advisor can generally determine to retain electronically those records that he creates electronically. However, if an RIA chooses to do so, it should have policies and procedures pertaining to electronic record retention. The procedures should provide for maintaining, preserving, and accessing the records to ensure that the records are accurate, complete, and safe from loss, destruction, or tampering. Compling with Advisers Act Rule 204-2(g) requires that records stored in an electronic format be maintained on some micrographic medium (such as microfilm or microfiche) or other electronic storage medium (e.g., tape backup, DVD, or compact disc). Advisors should use a medium that does not allow the information to be altered or edited in any capacity.
In addition, the information contained in that medium must be organized in a manner that permits easy location, access, and retrieval. RIAs must be capable of producing legible copies of any particular record in response to regulatory requests in a short period of time. A firm may be required to produce the means by which records are accessed in their electronic, digital, or film format. For example, RIAs with microfilm versions of their records must have the facilities to access the microfilm and produce legible reproductions of firm records. As such, it may be beneficial for the advisory firm to retain the recordkeeping infrastructure on site. Records retained electronically must also be retained in duplicate form and stored in a separate location from the original.
Understandably, few advisors want to file and retain any more hard copy documents than those required under the Act. However, consider retaining original executed hard copies of substantive documents and correspondence, including advisory agreements, investment policy statements, and any correspondence to a client confirming that the client has determined to take (or not to take) substantive actions independent of, or contrary to, the advisor’s advice. Nothing will serve an advisor better, especially in a court or arbitration proceeding, than the “original” executed document.
What About E-mails?
Electronic correspondence (e.g., e-mail, instant messaging, etc.) must be maintained by SEC registered investment advisors pursuant to recordkeeping Rule 204-2, and by state registered advisors pursuant to similar state recordkeeping requirements. An advisor should be prepared to produce electronic correspondence during a regulatory examination. During an exam, it is SEC practice to initially request electronic correspondence of certain advisory firm members for a limited period of time (generally three months to one year), and then to subsequently enlarge the review period based on its findings. The substantive nature of the electronic correspondence will include both client correspondence and internal firm correspondence relative to the firm’s advisory clients and operations. Consequently, investment advisors should develop a written policy with respect to electronic mail retention and deletion.