Last week the U.S. Securities and Exchanges Commission (“SEC”) Division of Examinations released a pertinent risk alert for newly registered investment advisers (“newly registered advisers”). Since 2013, the SEC has expressed its interest in conducting examinations of newly registered advisers and even noted that the number of SEC-registered advisers has increased by more than 20% in the last five years. Because of this, the SEC has made a point to pay particular attention to any commonalities, potential risks, or issues that may arise for this new landscape of investors. In this newest risk alert, the SEC shared typical focus areas reviewed during examinations of newly registered advisers as well as some staff observations regarding various compliance-related policies, procedures, and practices. Below you’ll find a brief overview of this risk alert and what it means for newly registered advisers.
Examinations for Newly Registered Advisers
The SEC sees examinations for newly registered advisers as an ample opportunity for staff to provide these new advisers with pertinent information about the SEC’s examination program and procedures, conduct necessary preliminary risk assessments, promote responsible compliance with applicable regulations, and ultimately facilitate discussions regarding the adviser’s operations and potential risk characteristics. The SEC’s exams of newly registered advisers often focus on three main items of concern for the advisers:
Have the firms identified and addressed conflicts of interest?
Have the firms provided clients with full and fair disclosure such that clients can provide informed consent?
Have the firms adopted effective and robust compliance programs?
Overall Examination Scope
During these examinations, the SEC requests documents and info for a specific period to assess an adviser’s compliance with the Advisers Act while also determining whether the adviser’s practices and disclosures towards clients and SEC filings are consistent with an adviser’s actual day-to-day practices. Generally, this is seen as a basic overview, but still incredibly important.
Some of the general items that the SEC typically requests for review can include but aren’t limited to:
General info to provide the staff with an understanding of the adviser’s business and operations
Org charts
Documentation regarding SEC eligibility
Ownership/control and affiliate information
Info about current and former advisory personnel
Demographic and other specific data regarding each advisory client account
Advisory services provided (portfolio management, financial planning, etc.)
Type of client accounts serviced (defined retirement plan, private fund, etc.
Advisory authority to trade in the account (whether it has discretionary authority)4
Info regarding the adviser’s compliance program, risk management practices and framework, and internal controls
Info to facilitate staff testing for regulatory compliance in certain areas, including portfolio management and trading activities
Communication used by the adviser to inform or solicit new and existing clients
This general information gathering often includes staff interviews where the SEC staff may interview adviser personnel to gain a deeper understanding of their operations and activities.
Staff Observations from Recent Newly Registered Investment Adviser Exams
Key Takeaways
In their risk alert, the SEC mentioned three key areas where they had identified common issues during their examinations of recent newly registered advisers.
Compliance Policies and Procedures
The examination staff observed various compliance policies and procedures that didn’t adequately address certain risks applicable to the firm as well as omitted procedures to enforce the stated policies. Another primary concern is these policies not being followed by advisory personnel, often because the personnel were not even aware of the policies and procedures.
Other compliance issues the SEC staff noted included the use of off-the-shelf compliance manuals that were not tailored to the specific adviser and their business practices, undisclosed conflicts of interest created by individuals holding multiple roles and responsibilities, and an overall lack of devoted resources to comply with regulatory requirements.
Disclosure Documents and Filings
The SEC staff mentioned observations of inadequate disclosure documents and filings that often contained omissions or inaccurate information as well as untimely filings. The omissions and inaccuracies included information related to adviser fees and compensation, services offered to clients, and disciplinary actions, among other things.
Marketing
With the recent amendment of the Marketing Rule, the SEC has been paying closer attention to what kind of content firms distribute to clients and prospects as well as the types of messages they promote through this content. In the examinations of newly registered advisers, the SEC staff observed a myriad of adviser marketing materials that appeared to contain false or misleading information that the advisers were unable to substantiate.
The Core Conclusion
The items the SEC mentioned in this risk alert are not necessarily new but are nonetheless timely and important. Their observations revealed significant gaps in compliance programs while also displaying the innate need for detailed compliance programs from the start. As newly registered advisers begin to grow, it is vital that their compliance programs, procedures, and practices grow with them. If you are a newly registered adviser or are seeking SEC registration, don’t hesitate to reach out to the Joot team to level up your compliance game.
