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On July 23, the SEC's Office of Compliance Inspections and
Examinations (OCIE) released a risk alert setting
forth compliance issues that OCIE had observed during its series of
examinations of SEC-registered investment advisers
(RIAs) that previously employed or currently
employ supervised persons with a disciplinary history. OCIE
detected deficiencies in nearly all of the examined RIAs related to
compliance, disclosure of conflicts of interest and
supervision.
In 2017, OCIE conducted more than 50 examinations of RIAs
collectively managing approximately $50 billion in assets for
nearly 220,000 clients (most of them retail investors). OCIE
focused specifically on RIAs' practices in certain areas,
including the design of appropriate compliance programs and
implementation of supervisory oversight practices; the fairness and
accuracy of disclosures in public statements and documents; and the
identification, remediation and disclosure of conflicts of
interest.
OCIE observed that:
Nearly half of the examined RIAs omitted material disclosures
regarding their supervised persons' disciplinary history or
their own; disclosed incomplete, confusing or misleading
information regarding disciplinary events; and failed to timely
update their Form ADV and provide their clients with updated
disclosure documents.
Many of the examined RIAs failed to adopt and implement
compliance policies and procedures addressing the risks associated
with hiring and employing individuals with a prior disciplinary
history (for example, they were not able to identify whether the
supervised persons' self-attestations completely and accurately
described disciplinary events or whether such supervised persons
were not actually subject to reportable events or
bankruptcies).
Additionally, OCIE detected issues that were not necessarily
attributable to the RIAs' hiring and supervision of supervised
persons with a disciplinary history. OCIE observed that:
A large number of the examined RIAs' policies and
procedures did not sufficiently describe the responsibilities of
and did not clearly outline the expectations for their supervised
persons, including oversight of fee disclosures, advertising
material preparation and remote working arrangements.
Many of the examined RIAs did not confirm that their supervised
persons responsible for performing certain compliance policies and
procedures were actually executing their duties, including key
regulatory and business responsibilities such as monitoring the
appropriateness of client account types and maintaining true and
accurate financial books and records.
Several RIAs had adopted policies and procedures that were
inconsistent with their actual business practices and disclosures,
including those related to commissions, fees and expenses.
Certain RIAs' annual compliance reviews were not adequately
documented, and firm-related risks were not appropriately assessed
or even identified at all.
Several RIAs had undisclosed conflicts of interest, some of
which related to compensation arrangements. For example, OCIE found
that forgivable loans were made to certain persons that would be
forgiven upon certain client-based incentives being met, thereby
potentially causing those persons to increase the fees and/or
expenses borne by the clients.
Finally, OCIE suggested several ways for RIAs to improve their
regulatory compliance when employing supervised persons with a
prior disciplinary history, such as adopting written policies and
procedures clearly addressing what to do before hiring such
individuals, and adopting policies and procedures that address
client complaints related to their supervised persons; enhancing
due diligence practices as part of the hiring process for such
individuals (for example, performing thorough background checks,
conducting internet and social media searches, fingerprinting,
reviewing new hires' Form U5, and checking the CRD/IARD system
at the time of hire as well as at a later time in order to
cross-check disciplinary information, etc.); and strengthening the
oversight of supervised persons with a known disciplinary history
and of those working remotely.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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