A Risk Alert regarding its National Exam Program was issued by the SEC’s Office of Compliance Inspections and Examinations or OCIE. Drawing from its prior exam experience, OCIE identified five key areas of risk for investment advisers. Each point is highlighted by examples which should facilitate exam preparation and compliance for investment advisers.
Area 1 — Compliance Rule: Under this rule an adviser is prohibited from giving investment advice to a client unless certain requirements are met. Specifically, the adviser must: a) adopt and implement written compliance procedures; b) review those procedures at least annually for effectiveness; and c) designate a COO charged with administering the policies and procedures.
Examples of failures to properly comply with this rule include: Having policies and procedures which are not tailored to the adviser’s business; not performing – or not adequately performing – the annual review; failing to follow the adviser’s policies and procedures; and having an out of date compliance manual.
Area 2 – Regulatory Filings: Advisers are required to file certain regulatory filings which include Form ADV (filed annually), Form PF for advisers to one or more private funds with assets of over $150 million; and Form D, required to be filed no later than 15 days after the first sale of securities in the offering of a private fund.
Examples of failures include: Inaccurate disclosures; untimely amendments to Form ADV; incorrect and/or untimely filing of Form PF; and incorrect and/or untimely filing of Form D.
Area 3 – Custody Rule: Advisers who have custody of client cash or securities or the authority to obtain possession of them must comply with the rule. The rule has a series of requirements keyed to the protection of client assets.
Examples of failures include: A failure to recognize that the adviser has custody which can, for example, occur when the adviser has online access to client accounts; and obtaining a surprise exam (one of the options for complying with the rule) that does not meet the requirements of the rule because it is not a surprise since it is conducted on the same date each year.
Area 4 – Code of Ethics: Advisers are required to have a Code of Ethics – disclosed in Form ADV Part 2A — that has three key elements: a) establishes standard business conduct for supervised persons; b) requires access persons to periodically report personal securities transactions and holdings to a designated person; and c) requires that access persons obtain the adviser’s pre-approval before investing in an IPO or private placement.
Examples of failures include: A failure to identify access persons; the required elements are not included in the code; access persons do not report holdings in a timely manner; and a failure to disclose the Code as required.
Area 5 – Books and Records Rule: Advisers are required to keep and maintain certain books and records with include typical accounting and other business records.
Examples of failure include: A failure to maintain all of the required records; records that are either not updated or are inaccurate; and inconsistent records.
Since failures in these areas can, at a minimum, result in remedial action or, in certain instances, a referral to the Division of Enforcement for appropriate action, advisers should carefully review these points to ensure compliance.