The Securities and Exchange Commission’s exam division plans to launch an exam sweep of registered investment advisors that employ or contract with supervised persons with a disciplinary history.
In its Monday Risk Alert, the SEC’s Office of Compliance Inspections and Examinations (OCIE) stated such individuals “may present an increased risk of future misconduct, and thus can present harm to clients.”
The exams are expected to begin fiscal 2017, which starts Oct. 1, 2017.
SEC staff will pick which advisors to examine based on:
• Disciplinary information that is reported on an advisor’s Form ADV.
• Information about other legal actions (e.g., private civil actions) not required to be reported on Form ADV, but which is nonetheless relevant to the advisory services offered to clients.
• Information from SEC enforcement actions that barred or suspended individuals from certain financial industries.
Exams under the “Supervision Initiative” will focus on evaluating the effectiveness of advisors’ compliance programs, supervisory oversight practices and disclosures to clients and prospective clients, particularly relating to the potential risk associated with financial arrangements initiated by supervised persons with a disciplinary history, the SEC said.
Richard Ketchum, the former CEO of the Financial Industry Regulatory Authority, warned at FINRA’s annual conference in May that the self-regulator was placing heightened scrutiny on firms that hire recidivist brokers, as it could be a sign of “poor firm culture.” Ketchum noted at the event that ”the response or lack of response [from firms to examiner inquiries] certainly increases the likelihood of an enforcement action. Similarly, recidivist behavior can be an indicator of poor culture, and is certainly likely to result in more severe penalties.”
OCIE will zero in on four areas:
• Compliance Program Rule 206(4)-7 under the Advisers Act, which requires advisors to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act. Examiners will review the advisor’s practices regarding its hiring processes, ongoing reporting obligations, employee oversight practices and complaint handling processes.
• Disclosures as they apply to statements made in an advisor’s Form ADV Part 1 and brochure. An advisor must update its brochure at least annually (and more frequently if required by the instructions on Form ADV) and notify clients of any material changes. Examiners will likely review registered advisors’ practices regarding their disclosures of regulatory, disciplinary or other actions with a focus on assessing the accuracy, adequacy and effectiveness of such disclosures.
• Conflicts of interest. Examiners will pay particular attention to conflicts that may exist with respect to financial arrangements (such as unique products, services or discounts) initiated by supervised persons with disciplinary events.
• Marketing under Rule 206(4)-1 under the Advisers Act prohibits an advisor from including certain representations in its ads or marketing materials. Examiners will review an advisor’s ads including pitch-books, website postings, and public statements to identify any conflicts of interests or risks associated with supervised persons with a history of disciplinary events.
— Related on ThinkAdvisor: