Top Compliance Fails Investment Advisers Should Avoid

Investment Advisers’ Top Five Compliance Fails

As investment advisers conduct their annual review, they can learn a lot from their peers. The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) recently issued a Risk Alert detailing the five compliance topics most frequently identified in deficiency letters that were sent to registered investment advisers.Below is a brief summary of the SEC risk alert:

(1) Compliance Rule

Advisers Act Rule 206(4)-7 makes it unlawful for an adviser to provide investment advice to clients unless the adviser: (1) adopts and implements written policies and procedures reasonably designed to prevent violation, by the adviser and its supervised persons, of the Advisers Act and the rules that the Commission has adopted under the Advisers Act; (2) reviews, no less frequently than annually, the adequacy of its policies and procedures and the effectiveness of their implementation; and (3) designates a chief compliance officer responsible for administering the compliance policies and procedures that the adviser adopts. In conducting examinations, the SEC identified the following deficiencies or weaknesses:

• Compliance manuals are not reasonably tailored to the adviser’s business practices, i.e. off-the-shelf manuals.
• Annuals reviews are not held or neglect to assess the adequacy of the adviser’s policies and procedures.
• Advisers fail to follow compliance policies and procedures.
• Compliance manuals are not updated and contain information or policies that are no longer current.

(2) Regulatory Filings

Advisers are obligated to accurately complete and timely file certain regulatory filings and disclosures with the SEC, including Form ADV, Form PF, and Form D. The Risk Alert provides the following examples of deficiencies or weaknesses with respect to adviser regulatory filing obligations

• Advisers made inaccurate disclosures on Form ADV brochures, such as inaccurately reporting custody information, regulatory assets under management, disciplinary history, types of clients and conflicts.
• Advisers failed to promptly amend their Form ADVs when information became inaccurate or timely file their annual updating amendments.
• Advisers did not complete the Form PF accurately or completely.
• Advisers did not accurately complete and timely file Form Ds on behalf of their private fund clients.

(3) Custody Rule

Advisers with custody of client cash or securities must comply with the Custody Rule, which prescribes several requirements intended to safeguard client assets from unlawful activities or financial problems of the adviser. The SEC identified the following common compliance violations of Advisers Act Rule 206(4)-2:

• Advisers may not have properly identified custody related to having access to online accounts using clients’ personal usernames and passwords.
• Advisers with custody underwent surprise examinations that did not meet the requirements of the rule, i.e. the exams were not really a “surprise.”
• Advisers were not aware that they may have custody because of certain authority over client accounts, i.e. powers of attorney.

(4) Code of Ethics Rule

Pursuant to Advisers Act Rule 204A-1, advisers must adopt and maintain a code of ethics. The code of ethics must: (1) establish a standard of business conduct that the adviser requires of all its supervised persons; (2) require an adviser’s “access persons” to periodically report their personal securities transactions and holdings to the adviser’s chief compliance officer or other designated persons; and (3) require that access persons obtain the adviser’s pre-approval before investing in an initial public offering or private placement. The SEC identified the following examples of deficiencies or weaknesses with respect to the Code of Ethics Rule:

• Advisers failed to identify all their access persons (e.g., certain employees, partners or directors) for purposes of reviewing personal securities transactions.
• Advisers’ codes of ethics were missing required information, including failing to specify review of the holdings and transactions reports and failing to identify the specific submission timeframes.
• Access persons submitted transactions and holdings less frequently than required by the Code of Ethics Rule.
• Advisers did not describe their codes of ethics in their Part 2A of Form ADVs and did not indicate that their codes of ethics are available to any client or prospective client upon request.

(5) Books and Records Rule

The Books and Records Rule requires advisers to make and keep certain books and records relating to their investment advisory business. The SEC highlighted the following compliance failures:

• Failure to maintain all the books and records required by the rule, such as trade records, advisory agreements and general ledgers.
• Errors and omissions in their books and records, such as inaccurate fee schedules and client records or stale client lists.
• Advisers maintained contradictory information in separate sets of records.

This article provides only an overview of the issues discussed in the Risk Alert. Registered advisers should thoroughly review the document and work with experienced counsel to ensure that you have robust practices, policies and procedures in these areas.

Do you have any questions? Would you like to discuss the matter further? If so, please contact me, Dan Brecher, at 201-806-3364.