The SEC Division of Examinations recently issued a Risk Alert addressing compliance issues that are faced by investment advisers that have recently registered with the SEC (“newly-registered advisers”). While the SEC noted that newly registered advisers faced unique compliance risks and issues, it appears that those risks and issues are basic to advisory compliance and are faced by many advisers that have not been subject to a SEC exam recently.
Newly Registered Adviser Examinations
While Examinations of newly registered advisers address the same basic compliance issues faced by all advisers, it is generally focused on the basics, i.e., have the firms identified and addressed conflicts of interest and are they providing clients with full and fair disclosure such that clients can provide informed consent; and have the firms adopted effective compliance programs. As with all examinations, a primary goal is to assess the adviser’s compliance with the Advisers Act and to determine whether the adviser’s representations and disclosures made to its clients and in SEC filings are consistent with the adviser’s actual practices.
To that end, the scope of information generally requested and reviewed by the SEC staff includes:
- General information to provide the staff with an understanding of the adviser’s business and operations, which includes organizational charts, documentation to support eligibility for SEC registration, information about ownership and control of the adviser and its affiliates; financial information and information about any threatened, pending, or settled litigation or arbitration involving the adviser or any of its supervised persons.
- Demographic and other specific data regarding each advisory client account, including in part information about the advisory services provided, such as portfolio management, financial planning, and/or bundled wrap fee arrangements, the types of client accounts serviced, such as individual, defined benefit retirement plan, registered fund, or private fund, advisory authority to trade in the account, such as whether it has discretionary authority, third-party service providers, such as custodians, administrators, and auditors.
- investmentstrategies,suchasglobalequity,high-yield,aggressivegrowth,long-short,or statistical arbitrage.
- Information regarding the adviser’s compliance program, risk management practices and framework, and internal controls, including written compliance policies and procedures and the adviser’s code of ethics.
- Information to facilitate the staff testing for regulatory compliance in certain areas, including portfolio management and trading activities, such as a record of specific information for all advisory clients’ securities holdings and transactions.
- Communication used by the adviser to inform or solicit new and existing clients, including disclosure documents and advertising, such as pamphlets, social media, mass mailings, websites, and blogs.
Examination Observations
The staff’s review of recent newly registered adviser examinations identified issues in the following three areas, among others: (1) compliance policies and procedures; (2) disclosure documents and filings; and (3) marketing. Each of these areas is described further below.
- Compliance Policies and Procedures. The staff observed compliance policies and procedures that: (a) did not adequately address certain risk areas applicable to the firm, such as portfolio management and fee billing; (b) omitted procedures to enforce stated policies, such as stating the advisers’ policy is to seek best execution, but not having any procedures to evaluate periodically and systematically the execution quality of the broker-dealers executing their clients’ transactions; and/or (c) were not followed by advisory personnel, typically because the personnel were not aware of the policies or procedures or the policies or procedures were not consistent with their businesses.
- Disclosure Documents and Filings. The staff observed required disclosure documents that contained omissions or inaccurate information and untimely filings (e., material or annual form updates were not made within prescribed timeframes or at all). The disclosure omissions and inaccuracies were related to advisers’: (a) fees and compensation; (b) business or operations (including affiliates, other relationships, number of clients, and assets under management); (c) services offered to clients, such as disclosure regarding advisers’ investment strategy (including the use of models), aggregate trading, and account reviews; (d) disciplinary information; (e) websites and social media accounts; and (f) conflicts of interest.
- Marketing. The staff observed adviser marketing materials that appeared to contain false or misleading information, including inaccurate information about advisory personnel professional experience or credentials, third-party rankings, and performance. Advisers were also unable to substantiate certain factual claims.
Takeaways
The primary takeaway from the staff’s observations of the examinations of newly registered firms is that all advisers should remain focused on their core compliance issues, including the review of their compliance policies and procedures, marketing, and disclosures related to their operations and conflicts of interest. The obligation to assess their supervisory, compliance, and/or other risk management systems related to these risks, and make any changes, as may be appropriate, to address or strengthen such systems is an ongoing obligation of all advisers.