As we previously indicated, many investment advisers registered with the U.S. Securities and Exchange Commission (“SEC”) still have trouble meeting the requirements of Rule 206(4)-7 under the Investment Advisers Act of 1940 (“Investment Advisers Act”). Pursuant to Rule 206(4)-7, investment advisers registered with the SEC are required to establish and maintain written policies and procedures reasonably designed to prevent violations of the Investment Advisers Act and the rules under the Investment Adviser Act. Most state securities regulations have similar requirements and many state registered investment advisers also have trouble complying with these requirements.
Most investment advisers understand that they must have written policies and procedures in place and many investment advisers have developed something that could be provided upon request from the SEC or state securities regulator. However, many investment advisers end up with deficiencies in this area because the investment advisers have not taken adequate steps to: (1) understand what is in their written policies and procedures; (2) customize it specific to their firm’s situation; or (3) update it as needed. Investment advisers must develop policies and procedures that are designed to prevent, detect, and correct violations of the Investment Advisers Act or state securities regulations, as applicable. In order for an investment adviser to develop an effective compliance program, the investment adviser must first identify the areas where the investment adviser or its supervised persons are at risk of violating the Investment Advisers Act or applicable state securities regulations.
An effective compliance program should have in place written policies and procedures built around the identified, unique risks faced by the investment adviser based on the investment adviser’s conflicts of interests, business model, and practices. An investment adviser’s written policies and procedures should specifically address how the investment adviser will prevent, detect, and correct violations that may occur as a result of the investment adviser’s identified risks. Investment advisers should conduct a risk assessment when first establishing their compliance policies and procedures and should then review their risk inventory at least annually as part of the required review of the written policies and procedures. The risk assessment is imperative to developing an effective customized compliance program. In the absence of conducting a risk assessment, an investment adviser fails to identify the unique risks associated with the firm and, therefore, cannot adequately establish procedures to detect and prevent violations that may occur.
The SEC has taken enforcement actions against investment advisers that highlight the importance of having in place customized policies and procedures and effective compliance programs. In one enforcement action, the final order indicated that it appeared that the investment adviser used an off-the-shelf template manual that was not customized to the investment adviser’s unique business model. In a similar enforcement action, the order indicated that the firm initially failed to adopt written compliance policies and procedures reasonably designed to prevent violations and, after an examination by the SEC and notice of the deficiency, the firm adopted written compliance policies and procedures but failed to fully implement a compliance program. These investment advisers were both warned about their compliance deficiencies prior to the enforcement actions, but failed to take proper corrective actions. In a third example, the order indicated that the investment adviser’s failure to adopt and implement written compliance policies and procedures designed to prevent violations resulted in various trading, fee billing, and fee disclosure violations. In a release regarding these three cases, Robert Kaplan, former Co-Chief of the SEC Division of Enforcement’s Asset Management Unit, stated, “The failure to adopt and maintain adequate compliance policies and procedures is a significant violation of the federal securities laws. We will continue to work with our counterparts in the national exam program to identify investment advisers that put their investors at risk by failing to take their compliance obligations seriously.”
Investment advisers may purchase an off-the-shelf template to begin the process of preparing written policies and procedures, but investment advisers that do so must then customize it to the investment adviser’s unique business model. An investment adviser’s written policies and procedures should not only identify the policies and procedures that are in place, they should also identify who in the firm is responsible for preforming the task, when each task is expect to be conducted, and what documents or records will be prepared and maintained for each of the tasks defined in the policies and procedures. The process of developing written compliance policies and procedures is not something that is ever finished. Investment advisers should look at developing policies and procedures as an ongoing process. At a minimum, investment advisers will need to revise and update their procedures as the firm changes (e.g., new owners/officers, new products, new services, new employees/investment adviser representatives) or as regulations change. Rule 206(4)-7 requires SEC registered investment advisers to perform a review of their written policies and procedures at least annually. Most states have similar requirements. Investment advisers will need to look at the findings resulting from the annual reviews and determine if new policies and procedures need to be added or if existing ones need to be updated.
RIA Compliance Consultants is hosting a webinar to help investment advisers understand the need to and process for developing an effective compliance program. Our webinar, “Developing and Implementing an Effective Customized Compliance Program,” will provide an overview of Rule 206(4)-7 under the Investment Advisers Act and will discuss the importance of and process for developing and maintaining a customized program to address the specific risks and conflicts of interest associated with each firm’s business model, conflicts of interest, and affiliations. Our consultants will also discuss the value of ongoing monitoring and testing in addition to the annual compliance review process in order to ensure that the policies and procedures are written to reasonably prevent violations of the Investment Advisers Act and the rules thereunder. Additionally, our consultants will discuss the need to make sure that all supervised persons understand and comply with the firm’s policies and procedures in order to promote a strong compliance culture throughout the firm. To register for this event, click here.