The most frequently addressed and audited topics we shared in a “risk alert” sent out by the SEC. The Securities and Exchange Commission’s website says that their mission is to “protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.
The SEC strives to promote a market environment that is worthy of the public’s trust.” Last year they alerted investment advisers of compliance inspections and examinations prior to them taking place. They informed the public that there would be certain things addressed in these inspections, specifically the top deficiencies facing the industry. The following are red flags that you might avoid when being audited by the Securities and Exchange Commission.
Incorrect or Delayed Regulatory Filings
There are shortcomings when it comes to regulatory filings that cost organizations a lot of time and productivity to have reversed. Most notably, inaccurately reporting custody information, assets, disciplinary action, and amendments to ADVs. These are the uniform registration templates used to register with federal and state authorities. Other transgressions include untimely Private Fund (PF) form filings and incorrect Form D filings. These regulations are so minor, they’re easy to overlook. However, they can cost investment advisors a year’s salary.
In August 2016, 13 investment advisory firms were found to have violated securities laws by making false claims. The fines ranged from $100,000 to $500,000 dollars based on each firm’s earnings. These fines seem a bit extreme considering the average investment adviser’s salary is only about $89,000 USD. The firms were small to mid-level firms so you can imagine the imapct these fines had on their bottom line.
Failure to Abide by the “Code of Ethics”
Granting access to unidentified individuals, missing codes of ethics on your website, not specifying audits of financial reports and their submission windows, and late submission of transactions and holdings each garner a hefty penalty. Not having a description of the code of ethics attached to Form ADVs is also a violation under the SEC’s “Code of Ethics” rule.
The SEC’s Compliance Rule
It is considered unlawful to provide investment advice to clients without the proper staff in correspondence with the client. There must be a designated compliance officer that administers and implements written policies and reviews those policies annually with clients. Compliance manuals are not sufficient to abide by this regulation because they’re not tailored to each adviser’s business practices. Specifically drafted manuals may suffice, but there are strict regulations on what should be addressed. Annual reviews are also a requirement and they must address the adherence of the adviser to their pre-supposed policies, protocols, and procedures. It is also a compliance rule that manuals stay current and are updated regularly.
Failure to Abide by the SEC’s “Custody Rule”
If an adviser fails to recognize “custody” as an active account user for a specified client, they may be penalized. An adviser has “custody” of an account when they hold the ability to withdraw funds from the client accounts at will. Advisors have custody when they hold authority over client accounts and can use the ‘power of attorney’ to withdraw client securities. Custodial advisers may experience surprise examinations and audits. If said advisers fail to adhere to the “Custody Rule” they may have their license temporarily revoked, or face independent fines.
Ignoring the “Books & Records” Rule
This rule encourages advisers to hire designated bookkeepers relating to their investment advisory business. This may be in the form of accounting, or other business record keeping techniques. Cited violations include failure to maintain detailed trade records, agreements, and failure to update client documentation (fee schedules, stale lists, etc).
If your books or records are inaccurate, they result in inconsistency. Inconsistent recordkeeping adds uncertainty to the overall dealings of your business. This can make for additional scrutiny, and stricter policy enforcement when being audited.
The SEC said they released this risk alert because they “hope to encourage advisers to reflect upon their own practices, policies, and procedures in these areas and to promote improvements in investment adviser compliance programs.” I believe it’s much more likely they’re planning to enforce these policies to the fullest extent in the near future. As many market predictors fear we’re edging on another market crash, the increased enforcement of SEC policies and regulations doesn’t surprise me. On the bright side, the SEC is being transparent in warning advisers of what’s to come. They’re genuinely informing the public that they’ll take you down for failing to abide by their policies, regardless of your abilities as an investor.
If you witnessed or experienced an Investment Adviser committing any of these violations, please fill out this form. It is our goal to assist ethical businesses in abiding by federal rules and regulations before incurring fines. We work hard to identify potential violations and non-compliance that can be corrected. However, we also report unethical treatment of consumers or employees when a business is no longer serving the best interest of the public at large.
Digital Compliance Analyst
Alex is a Digital Compliance Analyst at FACC. She’s passionate about ethical growth and fond of open-source, productivity hacking, and remediation. As a hot yoga and dog lover, she enjoys working in her office in Miami Beach and remotely. Follow her on Twitter at @lexmontgomeryxo.