Paul A. Lieberman
Partner
732-568-8366 plieberman@sh-law.comSEC Risk Alert Sounds the Alarm Over Multi-Branch Risks
Author: Paul A. Lieberman|December 14, 2020
The SEC is concerned about the results of recent examinations of registered investment advisers operating from numerous branch offices...
SEC Risk Alert Sounds the Alarm Over Multi-Branch Risks
The SEC is concerned about the results of recent examinations of registered investment advisers operating from numerous branch offices...
The SEC is concerned about the results of recent examinations of registered investment advisers operating from numerous branch offices...
The Securities and Exchange Commission (SEC) is concerned about the results of recent examinations of registered investment advisers operating from numerous branch offices. According to a recent Risk Alert, issued on November 9, 2020, by the SEC’s Office of Compliance Inspections and Examinations (OCIE) Multi-Branch Initiative (MBI) found several common deficiencies in the advisers’ compliance and supervisory practices. OCIE’s Multi-Branch Initiative evaluated the compliance and supervisory practices of advisory personnel working within the advisers’ branch offices.
The Risk Alert reflects observations from 40 examinations of advisers’ main offices combined with one or more examinations of each adviser’s branch offices. Most firms examined under the MBI conducted their advisory business out of 10 or more branch offices.
OCIE found that the adviser branch office model “may pose certain risk factors that advisors should consider in designing and implementing their compliance programs and in supervising personnel and processes occurring in branch offices.” The report noted and Risk Alert advised that the risks may be heightened when the main and branch offices have different practices. “For example, advisers that do not monitor, review, and/or test their branch office activities may not be aware that the compliance controls they have adopted are not effectively implemented or do not appropriately address the intended risks and conflicts in these remote locations.”
Multi-Branch Office Deficiencies Identified
OCIE staff focused on advisers’ compliance programs in both their main offices and branch offices, and on the oversight by the main offices of advisory services provided through branch offices. MBI found that more than one-half of these advisers had compliance policies and procedures that were: (1) inaccurate because they included outdated information, such as references to entities no longer in existence and personnel that had changed roles and responsibilities; (2) not applied consistently in all branch offices; (3) inadequately implemented because, among other things, the compliance department did not receive records called for in the policies and procedures; or (4) not enforced.
The Risk Alert also notes OCIE found compliance weaknesses related to the oversight and supervision of supervised persons. They included: (1) the failure to disclose material information, including disciplinary events of supervised persons; (2) portfolio management, such as the recommendation of mutual fund share classes that were not in the client’s best interest; and (3) trading and best execution, including enforcing policies and procedures the adviser had in place. Further, supervision deficiencies were particularly prevalent when the advisers oversaw branch office personnel with higher-risk profiles, which included instances related to the identification and documentation of disciplinary events.
The OCIE examinations also revealed that advisers often had deficiencies related to advertising (both generally and specifically) regarding the materials prepared by supervised persons located in branch offices and/or supervised persons operating under a name different than the primary name of the adviser (also known as “doing business as” or “DBAs”). According to the Risk Alert, examples of problematic advertisements included: (1) performance presentations that omitted material disclosures; (2) superlatives or unsupported claims; (3) professional experience and/or credentials of supervised persons or the advisory firm that were falsely stated; and (4) third-party rankings or awards that omitted material facts regarding these accolades.
OCIE staff evaluated the processes by which firms’ supervised persons located in branch offices provided investment advice to advisory clients, including the formulation of investment recommendations and the management of client portfolios. It found that more than one-half of the examined advisers were cited for deficiencies related to portfolio management practices. These often were related to: (1) oversight of investment decisions, including the oversight of investment decisions occurring within branch offices; (2) disclosure of conflicts of interest; and (3) trading allocation decisions.
Specifically, deficiencies related to oversight or assessments of investment recommendations were often related to mutual fund share class selection practices and disclosures of such practices, as well as investment recommendations and disclosures associated with wrap fee programs. In addition, several advisers were cited for issues related to conflicts of interest that were not fully and fairly disclosed, such as expense allocations that appeared to benefit proprietary fund clients over non-proprietary fund clients. Several advisers also did not fully and fairly disclose financial incentives for the advisers and/or their supervised persons to recommend specific investments. Other advisers were cited for: (1) the lack of documentation demonstrating the advisers’ analysis regarding obtaining best execution for their clients; (2) completing principal transactions involving securities sold from the firms’ inventory without prior client consent; and (3) inadequate monitoring of supervised persons’ trading, including the improper allocation of block trade losses to clients rather than to the supervised persons.
Multi-Branch Office ‘Best Practices’
OCIE highlighted that firms were also doing things right. The Risk Alert, states that a “range of practices with respect to branch office activities that firms may find helpful in their compliance oversight efforts.” Below are a few examples discussed in the report:
- Written Policies and Procedures: Advisers adopted and implemented written compliance policies and procedures that: (1) were applicable to all office locations and all supervised persons – regardless of whether these individuals were independent contractors or employees of the adviser; (2) include unique aspects associated with individual branch offices; and (3) specifically address compliance practices necessary for effective branch office oversight.
- Annual Testing: Advisers performed compliance testing or periodic reviews of key activities at all branch offices at least annually, with some firms conducting reviews more frequently.
- Prior Disciplinary Events: Advisers established compliance policies and procedures to check for prior disciplinary events when hiring supervised persons and periodically confirming the accuracy of disclosure regarding such information.
- Employee Training: Most advisers required compliance-related training for branch office employees, targeting areas identified as needing improvement based on their branch office reviews
Key Takeaways
Advisors with multi-branch offices are encouraged to read and distribute internally the OCIE Risk Alert in its entirety and conduct a self-evaluation of their own policies and procedures for potential compliance deficiencies. As highlighted by the SEC, when designing and implementing compliance and supervision frameworks, it is important to “consider the unique risks and challenges presented when employing a business model that includes numerous branch offices and business operations that are geographically dispersed and to adopt policies and procedures to address those risks and challenges.”
If you have questions, please contact us
If you have any questions or if you would like to discuss these issues further,
please contact Paul A. Lieberman or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.
SEC Risk Alert Sounds the Alarm Over Multi-Branch Risks
Author: Paul A. Lieberman
The SEC is concerned about the results of recent examinations of registered investment advisers operating from numerous branch offices...
The Securities and Exchange Commission (SEC) is concerned about the results of recent examinations of registered investment advisers operating from numerous branch offices. According to a recent Risk Alert, issued on November 9, 2020, by the SEC’s Office of Compliance Inspections and Examinations (OCIE) Multi-Branch Initiative (MBI) found several common deficiencies in the advisers’ compliance and supervisory practices. OCIE’s Multi-Branch Initiative evaluated the compliance and supervisory practices of advisory personnel working within the advisers’ branch offices.
The Risk Alert reflects observations from 40 examinations of advisers’ main offices combined with one or more examinations of each adviser’s branch offices. Most firms examined under the MBI conducted their advisory business out of 10 or more branch offices.
OCIE found that the adviser branch office model “may pose certain risk factors that advisors should consider in designing and implementing their compliance programs and in supervising personnel and processes occurring in branch offices.” The report noted and Risk Alert advised that the risks may be heightened when the main and branch offices have different practices. “For example, advisers that do not monitor, review, and/or test their branch office activities may not be aware that the compliance controls they have adopted are not effectively implemented or do not appropriately address the intended risks and conflicts in these remote locations.”
Multi-Branch Office Deficiencies Identified
OCIE staff focused on advisers’ compliance programs in both their main offices and branch offices, and on the oversight by the main offices of advisory services provided through branch offices. MBI found that more than one-half of these advisers had compliance policies and procedures that were: (1) inaccurate because they included outdated information, such as references to entities no longer in existence and personnel that had changed roles and responsibilities; (2) not applied consistently in all branch offices; (3) inadequately implemented because, among other things, the compliance department did not receive records called for in the policies and procedures; or (4) not enforced.
The Risk Alert also notes OCIE found compliance weaknesses related to the oversight and supervision of supervised persons. They included: (1) the failure to disclose material information, including disciplinary events of supervised persons; (2) portfolio management, such as the recommendation of mutual fund share classes that were not in the client’s best interest; and (3) trading and best execution, including enforcing policies and procedures the adviser had in place. Further, supervision deficiencies were particularly prevalent when the advisers oversaw branch office personnel with higher-risk profiles, which included instances related to the identification and documentation of disciplinary events.
The OCIE examinations also revealed that advisers often had deficiencies related to advertising (both generally and specifically) regarding the materials prepared by supervised persons located in branch offices and/or supervised persons operating under a name different than the primary name of the adviser (also known as “doing business as” or “DBAs”). According to the Risk Alert, examples of problematic advertisements included: (1) performance presentations that omitted material disclosures; (2) superlatives or unsupported claims; (3) professional experience and/or credentials of supervised persons or the advisory firm that were falsely stated; and (4) third-party rankings or awards that omitted material facts regarding these accolades.
OCIE staff evaluated the processes by which firms’ supervised persons located in branch offices provided investment advice to advisory clients, including the formulation of investment recommendations and the management of client portfolios. It found that more than one-half of the examined advisers were cited for deficiencies related to portfolio management practices. These often were related to: (1) oversight of investment decisions, including the oversight of investment decisions occurring within branch offices; (2) disclosure of conflicts of interest; and (3) trading allocation decisions.
Specifically, deficiencies related to oversight or assessments of investment recommendations were often related to mutual fund share class selection practices and disclosures of such practices, as well as investment recommendations and disclosures associated with wrap fee programs. In addition, several advisers were cited for issues related to conflicts of interest that were not fully and fairly disclosed, such as expense allocations that appeared to benefit proprietary fund clients over non-proprietary fund clients. Several advisers also did not fully and fairly disclose financial incentives for the advisers and/or their supervised persons to recommend specific investments. Other advisers were cited for: (1) the lack of documentation demonstrating the advisers’ analysis regarding obtaining best execution for their clients; (2) completing principal transactions involving securities sold from the firms’ inventory without prior client consent; and (3) inadequate monitoring of supervised persons’ trading, including the improper allocation of block trade losses to clients rather than to the supervised persons.
Multi-Branch Office ‘Best Practices’
OCIE highlighted that firms were also doing things right. The Risk Alert, states that a “range of practices with respect to branch office activities that firms may find helpful in their compliance oversight efforts.” Below are a few examples discussed in the report:
- Written Policies and Procedures: Advisers adopted and implemented written compliance policies and procedures that: (1) were applicable to all office locations and all supervised persons – regardless of whether these individuals were independent contractors or employees of the adviser; (2) include unique aspects associated with individual branch offices; and (3) specifically address compliance practices necessary for effective branch office oversight.
- Annual Testing: Advisers performed compliance testing or periodic reviews of key activities at all branch offices at least annually, with some firms conducting reviews more frequently.
- Prior Disciplinary Events: Advisers established compliance policies and procedures to check for prior disciplinary events when hiring supervised persons and periodically confirming the accuracy of disclosure regarding such information.
- Employee Training: Most advisers required compliance-related training for branch office employees, targeting areas identified as needing improvement based on their branch office reviews
Key Takeaways
Advisors with multi-branch offices are encouraged to read and distribute internally the OCIE Risk Alert in its entirety and conduct a self-evaluation of their own policies and procedures for potential compliance deficiencies. As highlighted by the SEC, when designing and implementing compliance and supervision frameworks, it is important to “consider the unique risks and challenges presented when employing a business model that includes numerous branch offices and business operations that are geographically dispersed and to adopt policies and procedures to address those risks and challenges.”
If you have questions, please contact us
If you have any questions or if you would like to discuss these issues further,
please contact Paul A. Lieberman or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.
