The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations has issued a new risk alert that details the five most frequent compliance topics identified in its examinations of investment advisers

Advisers should review their compliance programs and practices in light of the topics noted in the alert, OCIE says, The topics were identified through a review of deficiency letters sent to SEC-registered investment advisers following more than 1,000 examinations completed during the past two years.

Compliance rule

The compliance rule, Rule 206(4)-7 under the Investment Advisers Act, makes it unlawful for an adviser to provide investment advice to clients unless they designate a chief compliance officer responsible for administering the compliance policies and procedures that the adviser adopts.

Among the identified deficiencies and weaknesses in connection with the compliance rule:

Compliance manuals were not reasonably tailored to the adviser’s business practices.

Compliance programs did not take into account important individualized business practices such as the adviser’s particular investment strategies, types of clients, trading practices, valuation procedures and advisory fees.

Some advisers used “off-the-shelf” compliance manuals that have not been tailored to the adviser’s individual business practices.

Annual reviews were not performed or did not address the adequacy of the adviser’s policies and procedures.

Advisers appeared to not be following their compliance policies and procedures. Examples included those that did not adhere to certain practices relating to marketing, expenses or employee behavior required by their compliance manual.

Compliance manuals contained information or policies that are no longer current, including investment strategies that were no longer pursued or personnel no longer associated with the adviser and stale information about the firm.

Regulatory filings

Advisers are obligated to accurately complete and timely file certain regulatory filings with the Commission. Deficiencies and weaknesses identified by OCIE staff included:

Advisers made inaccurate disclosures on Form ADV Part 1A or in Form ADV Part 2A brochures, such as inaccurately reporting custody information, regulatory assets under management, disciplinary history, and types of clients and conflicts.

Advisers did not promptly amend Form ADVs when certain information became inaccurate or timely file their annual updating amendments.

Advisers with an obligation to file Form PF did not complete the form accurately or completely.

Advisers did not accurately complete and timely file Form Ds on behalf of their private fund clients.

Custody rule

Advisers with custody of client cash or securities must comply with the custody rule, Rule 206(4)-2 under the Advisers Act.

An adviser has custody if it or a related person holds, directly or indirectly, client funds or securities, or has any authority to obtain possession of them. The custody rule prescribes a number of requirements designed to enhance the safety of client assets by protecting them from unlawful activities or financial problems of the adviser.

Among the issues identified by OCIE:

Advisers did not recognize that they may have custody due to online access to client accounts.

Advisers did not provide independent public accountants performing surprise examinations with a complete list of accounts over which they have custody. 

OCIE staff observed indications suggesting that surprise examinations may not have been conducted on a truly “surprise” basis (conducted at the same time each year, for example).

Advisers failed to recognize that they may have custody as a result of certain authority over client accounts.

Code of Ethics rule

The code of ethics rule requires an adviser to adopt and maintain a code of ethics. The rule sets forth a number of requirements, including that each adviser’s code of ethics must: establish a standard of business conduct that the adviser requires of all its supervised persons; require an adviser’s “access persons” to periodically report their personal securities transactions and holdings to the adviser’s chief compliance officer or other designated persons; and that access persons obtain the adviser’s pre-approval before investing in an initial public offering or private placement.

In addition, an adviser must provide each supervised person with a copy of the code of ethics and any amendments, and require their supervised persons to provide the adviser with a written acknowledgement of their receipt. An adviser also must describe its code of ethics in its Form ADV Part 2A brochure and indicate that the code of ethics is available to any client or prospective client upon request.

Among the deficiencies cited by OCIE:

Advisers did not identify all of their access persons (for example, certain employees, partners or directors) for purposes of reviewing personal securities transactions.

Codes of ethics were missing required information. Some did not specify review of the holdings and transactions reports; others did not identify the specific submission timeframes.

Untimely submission of transactions and holdings.

No description of code of ethics in Form ADVs.

Books and Records rule

The Advisers Act, requires advisers to make and keep certain books and records relating to their investment advisory business, including typical accounting and other business records as required by the Commission. Deficiencies included:

Books and records were inaccurate or not updated.

Inconsistent and contradictory information was found in separate sets of records.

The examinations within the scope of the review resulted in a range of actions. Advisers took remedial measures such as enhancing written compliance procedures, policies or processes, changing business practices or devoting more resources or attention to the area of compliance. In addition, where appropriate, the staff referred examinations to the Division of Enforcement for further action. In sharing the information in this Risk Alert, OCIE hopes to encourage advisers to reflect upon their own practices, policies and procedures in these areas and to promote improvements in investment adviser compliance programs.