Rule 206(4)–7 under the Investment Advisers Act of 1940 (“Investment Advisers Act”) became effective in February of 2004, yet for many investment advisers this continues to be a common area where regulatory deficiencies are found. Under Rule 206(4)-7, investment advisers registered with the U.S. Securities and Exchange Commission (“SEC”) are required to adopt and implement written policies and procedures reasonably designed to prevent violations of the Investment Advisers Act. While Rule 206(4)-7 does not detail specific items that investment advisers must include in their policies and procedures, the final rule release indicates that investment advisers are required to “consider their fiduciary and regulatory obligations under the [Investment] Advisers Act and to formalize policies and procedures to address them.” Most state securities regulations have similar requirements for state registered investment advisers; however, every registered investment adviser must familiarize itself with the specific regulatory requirements of its governing regulatory authority.
Well-designed policies and procedures should allow the investment adviser to detect and promptly correct any violations that have occurred. Rule 206(4)-7 requires investment advisers to adopt their policies and procedures around identified areas of risk related to the investment adviser’s practice and business model. According to the final rule release, as part of an effective compliance program, an investment adviser’s policies and procedures should address, at a minimum, the following issues as they relate to the investment adviser’s business model:
- “Portfolio management processes, including allocation of investment opportunities among clients and consistency of portfolios with clients’ investment objectives, disclosures by the adviser, and applicable regulatory restrictions;
- Trading practices, including procedures by which the adviser satisfies its best execution obligation, uses client brokerage to obtain research and other services (“soft dollar arrangements”), and allocates aggregated trades among clients;
- Proprietary trading of the adviser and personal trading activities of supervised persons;
- The accuracy of disclosures made to investors, clients, and regulators, including account statements and advertisements;
- Safeguarding of client assets from conversion or inappropriate use by advisory personnel;
- The accurate creation of required records and their maintenance in a manner that secures them from unauthorized alteration or use and protects them from untimely destruction;
- Marketing advisory services, including the use of solicitors;
- Processes to value client holdings and assess fees based on those valuations;
- Safeguards for the privacy protection of client records and information; and
- Business continuity plans.”
Rule 206(4)-7 also requires each investment adviser to designate an individual to serve as the chief compliance officer (“CCO”). The CCO will be responsible for administering the investment adviser’s compliance policies and procedures. According to the final rule release the CCO should be “competent and knowledgeable regarding the [Investment] Advisers Act and should be empowered with full responsibility and authority to develop and enforce appropriate policies and procedures for the firm.” While the CCO can allocate the responsibilities for implementing the policies and procedures to other supervised persons of the investment adviser, the CCO must be an individual in a position of sufficient seniority and authority within the investment adviser to compel all supervised persons of the investment adviser to comply with the investment adviser’s written policies and procedures.
In addition to the previously mentioned requirements, under Rule 206(4)-7, an investment adviser is required to review its policies and procedures at least annually. The annual review should be used to determine the adequacy and effectiveness of the investment adviser’s existing policies and procedures. When conducting the annual review, an investment adviser should consider any changes or violations that have occurred during the previous year that may now need to be addressed within the investment adviser’s written policies and procedures. An investment adviser should maintain records to support the annual review process and to document any findings, positive or negative, resulting from the review.
In order to develop an effective compliance program, an investment adviser first needs to be aware of its regulatory requirements and how such requirements pertain to the investment adviser’s business model. Regulators frequently emphasize the need for investment advisers to develop and maintain a culture of compliance; developing and implementing a strong, customized compliance program can help an investment adviser in creating a culture of compliance throughout the firm.
RIA Compliance Consultants is hosting a webinar during which we will provide an overview of the requirement for an investment adviser to develop written supervisory policies and procedures in accordance with Rule 206(4)-7 under the Investment Advisers Act and will expand on the importance of developing and maintaining a customized compliance program as well as the process for developing such a program in accordance with the investment adviser’s business model. This webinar, “Developing and Implementing an Effective Customized Compliance Program,” will be hosted Thursday, October 3, 2013, at 12:00 pm CDT. For more information or to register for this event, click here.