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Regulation and Compliance > Federal Regulation > SEC

SEC Is Getting Into the Weeds

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I’m on another flight as I type this, on my way to prepare another advisory firm for its visit from the grim reaper (aka, the SEC). I will continue to do so until the Senior PGA Tour calls and invites me to join (not holding my breath).

Although I continue to enjoy the weekly travel, the exam process and interactions with the commission have become increasingly onerous and complex. Although a good part of the reason for this is the current, very aggressive regulatory posture, the other factor is the increasingly complex world in which advisory firms operate.

The major areas on which the SEC continues to focus during exams are:

  • Custody. Trustee, standing letters and password issues.

  • Performance composites and non-composite presentations. Do your presentations adhere to regulatory requirements, including disclosures? The ability to use gross-of-fee presentations without showing results net-of-fees is limited. Do you really need to have them? Should you limit their use to one-on-one presentations upon specific request?

  • Assets under management. Do you really have as much as you indicate? Remember, the non-discretionary line is not a default line, and too many advisors continue to report assets on the non-discretionary line that do not count at all for AUM purposes.

  • Private investment vehicles. Suitability, due diligence and valuation.

  • Information security. I discussed the SEC’s cybersecurity initiative in my July column. I urge firms to review their cybersecurity processes, and also consider purchasing cyber-insurance (see Insurance Update, page 84).

  • Conflict disclosure. You all have conflicts (that means you, fee-only advisors). Have they been sufficiently and clearly disclosed?

  • Advertising and marketing practices. Do they meet regulatory standards?

  • Branch offices. Are you adequately monitoring operations and personnel?

The SEC is getting into the weeds in these areas, asking questions that it hasn’t in past years, many of them warranted. Specifically:

  • Custody. If you say you don’t have it, how do you know? Have you reviewed all of your accounts? Tested websites for which you maintain client passwords to confirm that possession of same does not rest in an adverse custody situation?

  • Monitoring and due diligence. If you claim that you are providing initial and ongoing review and monitoring of separate account managers and private investments (and getting paid an AUM fee for same), show or substantiate the due diligence, supporting records and processes to corroborate your initial and ongoing review and justify your ongoing fee.

  • Outside business activities. How do you monitor them? Do you have a policy? An outside business activity form that employees must complete initially upon employment and annually thereafter?

  • Branch offices, remote employees and reps. How do you monitor them? Can you provide supporting documentation to substantiate such supervision?

  • Valuations of private investment vehicles. If the underlying vehicles do not comprise exchange-listed securities that are marked to market (e.g., real estate, private equity and venture capital funds), how can you demonstrate to the commission that the value you are using to calculate your AUM fee is reasonable? Maintaining initial purchase price on an ongoing basis is generally not acceptable, especially without qualifying disclosure to the client, and even then it can be problematic.

  • Solicitors. How do you vet them initially and monitor on an ongoing basis? Do they need to be registered? Is there a written process? This is especially critical for firms whose business model means they materially rely on outside (unaffiliated) solicitors for new business.

  • Vendors. How do you vet and monitor those who have access to your offices or client information? Have they executed confidentiality agreements?


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