The Securities and Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations (OCIE) has provided advisers with a list of the five compliance topics most frequently identified in deficiency letters that were sent to registered investment advisers (RIAs).
Within each of the topics, SEC explains, a few examples of typical deficiencies are discussed to highlight the risks and issues that examiners commonly identified. Naturally, this information is intended to assist advisers during their own upcoming compliance reviews.
The first trend identified is deficiency involving Rule 206(4)-7, known as the “Compliance Rule” under the Investment Advisers Act of 1940. As the SEC explains, the Compliance Rule makes it unlawful for an adviser to provide investment advice to clients unless the adviser meets a series of hurdles. Among these are adopting and implementing written policies and procedures reasonably designed to prevent violations of the Advisers Act; regularly reviewing, no less frequently than annually, the adequacy of its policies and procedures and the effectiveness of their implementation; and designating a chief compliance officer to oversee such processes.
A range of violations are cited by SEC as regularly occurring in this area. Often compliance manuals are not reasonably tailored to the adviser’s business practices, or annual reviews are not performed diligently or do not address the adequacy of the adviser’s policies and procedures. Other advisers do not follow compliance policies and procedures they have clearly set out for themselves, while it is also likely that compliance manuals/processes may be sufficient in some areas while not entirely current in others.
The second high-level trend identified by SEC is broad deficiency in regulatory filings, including under Rule 204-1 of the Advisers Act, which requires advisers to amend their Form ADV at least annually, within 90 days of the end of their fiscal year and more frequently, if required by the instructions updated regularly for Form ADV. Further errors and violations occur under Rule 204(b)-1, which requires advisers to one or more private funds with private fund assets of at least $150 million to complete and file a report on Form PF.
In addition, SEC explains, Rule 503 under Regulation D of the Securities Act of 1933 generally requires issuers to file Form Ds—an area where failures commonly occur. SEC acknowledges that advisers typically file Form Ds on behalf of their private fund clients, and reminds them that generally, Form D is required to be filed no later than 15 calendar days after the first sale of securities in the offering of a private fund.
NEXT: Other widespread advisory failures
The SEC publication goes on to warn of widespread compliance failures under Rule 206(4)-2 of the Advisers Act, referred to as the “Custody Rule,” which applies to persons who hold, directly or indirectly, client funds or securities or has any authority to obtain possession of them
“Advisers commonly did not recognize that they may have custody due to online access to client accounts,” SEC warns. “An adviser’s online access to client accounts may meet the definition of custody when such access provides the adviser with the ability to withdraw funds and securities from the client accounts. The staff observed that certain advisers may not have properly identified custody as a result of them having access to online accounts using clients’ personal usernames and passwords.”
According to SEC, advisers with custody must be subject to “surprise” examinations, and many implement monitoring processes that do not meet the requirements of the Custody Rule. “The staff observed that certain advisers did not provide independent public accountants performing surprise examinations with a complete list of accounts over which the adviser has custody or otherwise provide information to accountants to permit the accountants to timely file accurate Form ADV-Es,” SEC notes. “In addition, staff observed indications suggesting that surprise examinations may not have been conducted on a surprise basis, e.g., exams were conducted at the same time each year.”
The other most common errors occur under Rule 204A-1 of the Advisers Act, known as the “Code of Ethics Rule,” and under Rule 204-2, or the “Books and Records Rule.”
Regarding establishing a proper code of ethics, SEC reminds advisers that it must “establish a standard of business conduct that the adviser requires of all its supervised persons; 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 require that access persons obtain the adviser’s pre-approval before investing in an initial public offering or private placement. In addition, SEC says, an adviser must provide each supervised person with a copy of the code of ethics and any amendments, and require their supervised persons to provide the adviser with a written acknowledgement of their receipt. An adviser also must describe its code of ethics in its Form ADV Part 2A brochure and indicate that the code of ethics is available to any client or prospective client upon request. Failures are commonly seen in all these areas, SEC warns.
On the “Books and Records Rule,” various failures commonly arise, such as advisers not maintaining all required records, such as trade records, advisory agreements and general ledgers. Some advisers have books and records that are wholly inaccurate or not adequately updated, and the staff “observed that certain advisers had serious errors and omissions in their books and records, such as inaccurate fee schedules and client records or stale client lists.”
The risk alert is available for download here.