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Regulation and Compliance > Federal Regulation > SEC

RIAs Fail to Vet, Disclose Advisors' Discipline History: SEC

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A Securities and Exchange Commission examination sweep has found significant weaknesses in how registered investment advisors hired, supervised and disclosed information about employees with disciplinary histories.

In a Wednesday Risk Alert, the agency’s Office of Compliance Inspections and Examinations revealed the results of 50 exams it conducted of RIAs that previously employed, or currently employ, any individual with a history of disciplinary events.

The RIAs collectively managed approximately $50 billion in assets for nearly 220,000 clients, the vast majority of whom were retail investors.

Advisors were identified for examination through a review of information about disciplinary events and other legal actions involving supervised persons of the advisor, including legal actions that are not required to be reported on Form ADV.

OCIE staff observed that nearly half of the disclosure-related deficiencies of the advisors examined were due to the firms providing inadequate information regarding disciplinary events.

For instance, advisors omitted material disclosures regarding disciplinary histories of certain supervised persons or the advisor itself.

“Often the disciplinary omissions related to supervised persons occurred because the advisors solely relied on these supervised persons to self-report to the firms information about their required disclosures,” the alert states.

OCIE also found that advisors included incomplete, confusing or misleading information regarding disciplinary events.

The RIAs at times failed to include the total number of events, the date for each event, the allegations, or whether the supervised persons were found to be at fault (i.e., whether fines, judgments or awards, or other disciplinary sanctions were imposed).

Some RIAs also failed to update disclosure documents and deliver them to clients after a new disciplinary event, the alert states.

Disclosure of Conflicts

OCIE also found that several advisors had undisclosed compensation arrangements, which resulted in conflicts of interests that could have affected the impartiality of the advice the supervised persons gave to their clients.

Some advisors failed to disclose that forgivable loans were made to the advisors or their supervised persons, the terms of which were contingent upon certain client-based incentives that may have unduly influenced the investment decision-making process, resulted in higher fees and expenses for the affected clients, or both.

Compliance Failures

Many advisors also failed to adequately supervise or set appropriate standards of business conduct for their supervised persons, while several advisors had adopted policies and procedures that were inconsistent with their actual business practices and disclosures.

Areas of inconsistent compliance practices most frequently cited by the staff involved those addressing commissions, fees, and expenses (e.g., solicitation fees, management fees, compensation related to hiring personnel, and oversight of firm compensation practices, including such practices within branch offices).

OCIE encouraged advisors, when designing and implementing their compliance and supervision frameworks, to consider the risks presented by, as well as the disclosure requirements triggered by, the hiring and employing of supervised persons with disciplinary histories and to adopt policies and procedures to address those risks and disclosure requirements.

“How many times must OCIE warn the industry about compliance, and how many enforcement actions will it take, before firms implement a legitimate compliance program?” Cipperman Compliance Services  said of the alert. “An investment advisor should spend at least 5% of revenue on compliance, hire a dedicated Chief Compliance Officer, adopt tailored policies and procedures, test the program every year, and prepare a written compliance report of deficiencies and remediation.”

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