Reasoned and Reasonable

o Risk assessment. I know of no rule that requires such an exercise. Is it prudent to conduct such an assessment? Yes, as part of the annual compliance review that is required under Rule 206(4)-7. However, that is not the issue–the issue is whether it is required. I read too many SEC deficiency letters that state it is required and that the advisor is deficient for not having conducted/prepared such an assessment. Why is that the case? Why not just recommend that the firm should consider it as part of its annual review? Why not, in the deficiency letter, delineate between regulatory violations and practice recommendations, and make it clear that the advisory firm will not suffer any penalty if it determines not to implement practice recommendations, particularly when such “recommendations” tend be very uneven and inconsistently applied throughout the various SEC branches around the country.

o The annual compliance review. When it comes to the annual review to be conducted by the Chief Compliance Officer of an RIA firm, how can the regulators cite an advisor as to the sufficiency/deficiency thereof when there has been little to no guidance from the regulators to advisors as to the form or content of the review?

o Appropriateness. Why do the Commission examiners sometimes spend one week or more examining a small fee-only mutual fund asset allocator advisory firm? Should it really take that long?

o Best execution. Although advisors are required to ensure that the clients receive best execution, the regulators have never specified how an advisor determines whether its clients are receiving it. I have heard too many different stories from too many advisors regarding the various ways examiners explained how an advisor can determine that it has discharged its best execution obligation (I will explain how an advisor can easily determine the same in one of my upcoming columns).

Thus, based upon the above, why not have uniform examinations for different types of advisors (i.e. institutions, smaller advisors vs. larger advisors, private investment fund [hedge fund] advisors, etc.) rather than using a one-size-fits-all examination? This pre-examination profiling can be easily accomplished based upon the information in Part 1 of Form ADV (i.e., type of entity, type of services, amount of assets, number of employees, etc.) and asking the advisor prior to commencing the exam to verify, in writing, that there have been no material changes thereto since the last filing.

Moreover, why are there inconsistencies between the content of examinations depending upon the region of the country–either slightly modified or sometimes significantly different? Are advisory practices different based upon geography? The vast majority of advisors operate very simple practices, and are too often intimidated by the examination process when they need not be. Why? Because the majority of the examination questions have little to no relevance to their practices (e.g., “step-out transactions,” order flow, revenue sharing, soft dollars, directed brokerage, private investment funds, etc.) Correspondingly, the risk assessment for such advisors should be a much simpler process, as should the examination process.

Compliance is the Goal

I commend the SEC for undertaking initial mini-reviews of newly registered advisors so it can rate an advisory firm on its “risk” level. I am hopeful that such efforts will be a starting point to better coordinate and streamline the process so as to make it more effective for advisors, regulators, and the public.

I continue to spend a great deal of my time traveling throughout the country preparing advisors for regulatory examinations. During the process, in conjunction with the advisor we identify areas that are in need of improvement, from both a regulatory and liability protection standpoint. The advisor will learn what does and does not apply to them from a day-to-day operational and from a regulatory examination perspective, as a result of which the advisor is able to substantially reduce its compliance efforts. Of course, the objective is not to become less compliant. Rather, the goal is to just become compliant! Too many advisors waste time, money, and energy by engaging in too many efforts that are either not required or have no relevance to their practices. Again, there arises misinformation, misinterpretation, and the failure to seek the right answer from someone who knows.

I submit that reasoned and reasonable regulations and examination formats would serve everyone’s best interests: the regulators, advisors, and clients alike. Advisors should know what their obligations are and effectively discharge them, but regulators should do a better job in identifying and explaining them. By so doing, it would permit regulators and advisors to be more efficient with their time and efforts. After all, they are all serving the same client, the investing public.

Thomas D. Giachetti is chairman of the Securities Practice Group of Stark & Stark, a law firm with offices in Princeton, New York, and Philadelphia that represents investment advisors, financial planners, broker/dealers, CPA firms, registered reps, and investment companies, and a regular contributor to Investment Advisor. He can be reached at [email protected].