State Exam Programs Reflect Improved Compliance by State Regulated Advisers

Every two years, state securities examiners voluntarily report sample data from their investment adviser examinations to the North American Securities Administrators Association’s (NASAA) Investment Adviser Operations Project Group.  The 2015 sample examination data was provided by 42 jurisdictions between January and June 2015 and as a result, NASAA has released the 2015 IA Coordinated Examinations Report.

The report reflects that the deficiencies uncovered declined from the previous series of state coordinated examinations, to wit, the 1,170 reported state examinations uncovered 4,983 deficiencies in 22 compliance areas; down 30 percent from the 6,482 deficiencies in 20 compliance areas reported in 2013.  Notwithstanding that, books and records continue to be the most problematic compliance area for state-registered investment advisers, accounting for more than twice as many deficiencies found by state examiners as the next highest problem area.

“The data suggests a robust state examination program and adherence to NASAA’s recommended best practices has helped investment advisers focus on remediating problem areas, which in turn reduces the risk of regulatory violations,” said William Beatty, NASAA President and Washington Securities Director.

Beatty noted that the examination results also suggest state-registered investment advisers should pay closer attention to their books and records practices. Beyond books and records issues, the top the list of five problem areas for state-registered investment advisers, which also included contracts, registration, fees, and custody.

Leading Problem Areas

The following are the leading problem areas found within the to five deficiency categories found by state securities regulators.

  • Books and records – not maintaining client suitability documentation and order memorandum.
  • Top contracts deficiencies – fees not explained and not having all contracts in writing.
  • Top registration deficiencies – inconsistencies between ADV Part 1 and ADV Part 2 and the timely filing of amendments.
  • Top fee deficiencies – fee charged does not match contract or ADV and unreasonable or excessive charges.
  • Top custody deficiencies: improper client invoice for direct fee deduction and dual invoicing of client and custodian for direct fee deduction.

Recommended Best Practices

Based on the 2015 sample data, NASAA recommends the following “Best Practices” as a guide to assist investment advisers in developing compliance practices and procedures.

  • Prepare and maintain all required records, including financial records. Back-up electronic data and protect records.
  • Prepare and maintain client profiles or other client suitability info.
  • Review and update all contracts. Make sure all fees are clearly noted and adequately explained in the contract.
  • Review and revise Form ADV and disclosure brochure annually to reflect current and accurate information. File amendments in a timely manner.
  • Prepare and distribute a privacy policy initially and annually.
  • Calculate and document fees correctly in accordance with contracts and ADV.
  • Keep accurate financials. File timely with the jurisdiction. Maintain surety bond if required.
  • Implement appropriate custody safeguards, paying attention to direct fee deduction if applicable.
  • Review all advertisements, including website and performance advertising, for accuracy.
  • Provide disclosure brochure to clients initially, then provide updates and offers to deliver afterwards as required.
  • Prepare a written compliance and supervisory procedures manual relevant to the type of business to include a business continuity plan.
  • Keep accurate financials. File timely with the jurisdiction. Maintain surety bond if required.
  • Review solicitor agreements, disclosures, and delivery procedures.

State securities regulators have regulatory oversight responsibility for investment advisers with assets under management of less than $100 million. Of the 823 investment advisers included in this year’s coordinated examinations, 232 had assets under management between of $30 million and $100 million and 591 had assets under management of less than $30 million. Under the Dodd-Frank Act, about 2,100 mid-sized investment advisers with assets under management between $30 million and $100 million switched from federal to state oversight in 2013.

Regulatory Takeaway

The top deficiencies continue to plague the advisory business, regardless of whether you are a state or federally regulated investment adviser.  To address that  trend, it would be appropriate to review the recommended best practices issued by NASAA and the SEC, and see how those practice are or can be incorporated into your practice.