RIAs Should React Quickly When Examiners Spot Deficiency Trends

by Beth cacciotti on October 28, 2015


When investment advisers hear about examinations that went badly for other firms, they often breathe a sigh of relief to learn that someone else is in trouble and not them. Advisers’ first reaction, however, should be to determine if their compliance programs are deficient in the same areas. They may be making the same mistakes as other Registered Investment Advisers (“RIAs”).


Firms should look at trends identified by NASAA


When compliance mistakes are common in a particular area, examiners may look there first when they examine an RIA. Whether an advisory firm is SEC or state-registered, RIAs should pay close attention to the findings of coordinated examinations conducted by state examiners. On September 28, 2015, the North American Securities Administrators Association (“NASAA”) published the results of coordinated investment adviser examinations. NASAA’s summary of these results was derived from data submitted to the organization between January and June 2015 by members of the organization.


Books and records mistakes and omissions were the most common deficiencies found by state securities examiners during their examinations. The rest of the top five problem areas identified by examiners were contracts, registration, fees, and custody.


State securities examiners found that the largest percentage of books and records deficiencies were in the area of suitability documentation. NASAA’s statistics showed that documentation related to order memorandums was also deficient at numerous firms.


The top contracts deficiencies were a failure to explain fees to clients and RIAs not having all contracts in writing. The major registration deficiencies were Form ADV inconsistencies between Part 1 and Part 2 and firms’ failure to file amendments in a timely manner.


The top fee deficiencies arose from instances where RIAs charged fees that were inconsistent with their advisory contracts or the firm’s Form ADV, or they charged unreasonable or excessive fees. The biggest custody deficiencies occurred when RIAs prepared improper client invoices for direct fee deduction, failed to provide invoices to clients, and engaged in dual invoicing of clients and custodians for direct fee deductions.


State securities examiners identified a number of other compliance errors. Deficiencies were found in many areas including advertising, compliance/supervision, financial matters, brochure delivery, pooled investments, and privacy. The highest percentage of privacy deficiencies resulted from a failure to deliver the firm’s privacy policy annually. A significant number of RIAs failed to deliver their privacy policies at the inception of the advisory relationship. Some RIAs had no privacy policy or an inadequate one.


Weak policies and procedures are often at the root of compliance deficiencies. NASAA’s report observed that the highest number of compliance/supervision deficiencies sprung from RIAs’ failures to have procedures to prevent misuse of material nonpublic information. Failure to periodically assess and update compliance/supervisory programs was also identified as a major issue. State examiners also found that advisory personnel failed to follow compliance/supervisory procedures.


NASAA’s report on examination deficiencies can be found at http://www.nasaa.org/37286/nasaa-reports-common-ia-deficiences/.


Trends identified this year are likely to be focused on next year


Now that NASAA has identified these problem areas, it is very likely that state examiners will pay even more attention to them during upcoming examinations. Furthermore, just as state securities regulators often follow the lead of the SEC, examiners for the Commission might take note of these problem areas to the extent they apply to federally registered advisers.


The SEC, state securities regulators, and FINRA are often focused on the same risks that investors may be facing. In many instances, potential problems have been identified by a sweep, which is an industry-wide examination that focuses on a specific risk area or compliance deficiency. For instance, on February 3, 2015, the SEC released a publication dealing with cybersecurity, which provided observations derived from examinations of more than one hundred broker-dealers and RIAs. In the months that followed, the SEC made it clear in word and deed that it will focus on cybersecurity during examinations. NASAA and FINRA have conveyed similar messages.


Examination trends are likely to develop in areas that are a high priority for securities regulators. On January 13, 2015, the SEC released the Office of Compliance Inspections and Examinations’ (“OCIE”) priorities for the year. Among other priorities, OCIE stated that it would allocate significant resources to protecting retail investors, especially retirees and individuals saving for retirement.  Later in the year, the SEC demonstrated that it was following through on that priority by launching a multi-year Retirement-Targeted Industry Reviews and Examinations (ReTIRE) Initiative. OCIE stated that it would examine certain federally registered advisers and broker-dealers as part of its National Examination Program and would focus on the risk of harm faced by retail investors saving for retirement.


One way to protect retail investors saving for retirement is by ensuring that IRA rollovers are suitable for the client. Every RIA should take immediate steps to ensure that the firm’s books and records document that it had a reasonable basis for recommendations made and that they were suitable for the client, especially with regard to IRA rollovers.


Best practices can help RIAs buck deficiency trends


Aside from identifying common deficiencies found during RIA exams, NASAA recommended a number of best practices to help firms avoid compliance deficiencies such as:


  • Preparing and maintaining all required books and records, including financial records, as well as backing up electronic data and guarding this information;
  • Developing and maintaining clients’ suitability information, including their risk profiles;
  • Reviewing and updating all contracts and making certain that all fees are clearly disclosed and explained thoroughly;
  • Reviewing and revising Form ADV and disclosure brochures annually to ensure that information is accurate and updated;
  • Conducting reviews to make certain that amendments are filed in a timely manner;
  • Preparing and distributing the firm’s privacy policy at the onset of a relationship and annual thereafter;
  • Verifying and documenting that fees were calculated in the manner set forth in contracts and Form ADV;
  • Maintaining accurate financial information that is timely filed with the jurisdiction and arranging for a surety bond if required by the state;
  • Putting necessary custody safeguards in place, including preparation and distribution of invoices to clients, if required by the state;
  • Reviewing all advertisements, including website and performance advertising, to ensure that they are not misleading or otherwise noncompliant;
  • Providing disclosure brochures to clients along with updates and offers to deliver when required by the state;
  • Drafting a written compliance and supervisory procedures manual that is tailored to the RIA’s business model, which includes a business continuity plan; and
  • Conducting reviews of solicitor agreements, disclosures, and delivery procedures implemented by the firm.


State and SEC-registered advisers can benefit by adopting these best practices. Advisory clients, however, are the ultimate beneficiaries when RIAs adopt best practices to reduce the mistakes made by other firms.




Trends can also be discerned by analyzing the SEC’s most recent enforcement actions. On October 22, 2015, the SEC announced its enforcement results for fiscal year 2015, which can be found at http://www.sec.gov/news/pressrelease/2015-245.html.


In addition, RIAs can anticipate some of the areas that examiners will be focused on during upcoming examinations. Aside from looking at deficiency trends, speeches made by securities regulators, and regulatory priority announcements, RIAs should take note of Investor Alerts. These alerts are frequently prompted when examiners discover deficiencies that resulted in harm to investors.  The last thing regulators want is for these deficiencies to become a trend that causes harm to even more investors.



Les Abromovitz is a senior consultant with the recently merged firms, National Compliance Services (NCS) and Regulatory Compliance, LLC, and the author of two books on compliance for investment advisers, including The Investment Advisor’s Compliance Guide, published in 2012 by the National Underwriter Company.  Les can be reached by calling (561)330-7645 (ext. 213) or by e-mailing labromovitz@ncsonline.com.

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