Never Been Examined?

The Securities and Exchange Commission (SEC) recently announced an examination initiative directed at “never before examined” registered investment advisers (RIAs), focusing on RIAs registered for three or more years.

SEC rules require RIAs to adopt policies and procedures that prevent, detect and correct violations of the Investment Advisers Act of 1940 (’40 Act), and to annually review whether these policies and procedures are effective. RIAs are expected to analyze their individual operations to identify conflicts of interest and other compliance-related risks, then address these risks in their policies and procedures. Each RIA must designate a chief compliance officer (CCO) responsible for its compliance program. To be ready for an SEC examination, RIAs must document the implementation and annual review of policies and procedures to meet these requirements, as well as keep filings, disclosure documents and required books and records up to date and accessible for examination.

The SEC said it will take two approaches when examining never-before-examined advisers. “Risk assessments” are expected to obtain a better understanding of an adviser’s overall business activities, focusing on the compliance program and essential documents. “Focused reviews” involve a more comprehensive inspection of “higher risk” areas, including compliance programs, filings and disclosure, marketing, portfolio management and safekeeping of assets.

Plan advisers occupy a specialized niche within a broader universe of RIAs and may offer a different range of services than others in the wider field. This means that compliance-related risks that pertain to plan advisers likely differ from the types of risks that may be relevant for other RIAs. Here are some compliance issues potentially applicable to plan advisers:

• Compensation. Does your firm or an affiliate—including an affiliated recordkeeper, third-party administrator (TPA) or broker/dealer (B/D)—receive compensation from money managers, mutual funds or other third parties in connection with investments by plan clients? Examiners are likely to look closely at how your firm manages and discloses conflicts that may arise in these circumstances.
• Other relationships. A 2005 SEC staff report addressing the activities of RIAs that identified themselves as pension consultants highlighted concerns about the independence of pension consultants that provide services to plans and also to money managers and mutual funds. If your firm has relationships with money managers and mutual funds that are recommended to plans, are these relationships fully disclosed? Do your firm’s policies and procedures include steps to eliminate or mitigate potential conflicts?
• Participant advice. What services does your firm provide to plan participants? If services are not limited to investment education, have you considered whether participants may be advisory clients of your firm and, if so, taken steps to comply with the disclosure and other requirements of the ’40 Act when providing advisory services to them?
• Rollover advice. Examination priorities for this year include looking at the sales practices of RIAs that target retirement-age workers to roll over assets from their employer-sponsored 401(k) plans into higher-cost investments. Determining whether advisers misrepresent their credentials or the benefits and features of an individual retirement account (IRA) or other alternatives will be included. If your firm advises plan participants about distributions and rollovers, do the firm’s policies and procedures address these concerns?
• Pay to play. Rules adopted in 2010 under the ’40 Act limit political contributions by RIAs and their employees if advisers seek to manage assets, including plan assets, of state and local governments. If your firm seeks business from plans maintained by those bodies, has the firm adopted policies and procedures to comply with pay-to-play rules?
• Custody. “Custody” is broadly defined by the SEC’s custody rule. For example, a plan adviser with authority to direct payment of plan assets to pay benefits or bills or to make investments may have custody, depending on the circumstances. Consider also whether your firm may have custody, if providing trustee or asset-management services. A final comment: Once you receive notice from SEC staff of an examination, you may have only a few days to provide requested documents and prepare for the on-site visit. Take steps to be ready now.