On July 23, 2019 the Office of Compliance Inspections and Examination’s (“OCIE”) of the U.S. Securities and Exchange Commission (“SEC”) released a Risk Alert about its assessment of the oversight practices of SEC-registered investment advisers who employ or employed individuals with disciplinary histories. Of the over 50 advisers that were examined, nearly all of the examined advisers received deficiency letters. The OCIE exams did not focus solely on supervisory practices as they relate to the individuals with prior disciplinary histories. Instead, OCIE reviewed the advisers’ supervisory practices firm-wide. OCIE’s findings relate to all investment advisers regardless of whether they have someone with a disciplinary history. The deficiencies identified related to compliance and disclosure issues, including undisclosed conflicts of interest.
OCIE observations specifically relating to advisers’ oversight of supervised persons with disciplinary histories were:
- Full and Fair Disclosure – OCIE observed that nearly half of the disclosure-related deficiencies of the advisers examined were due to the firms providing inadequate information regarding disciplinary events.
- Omitted material disclosures regarding disciplinary histories of certain supervised persons or the adviser itself
- Included incomplete, confusing, or misleading information regarding disciplinary events
- Did not update timely and deliver disclosure documents to clients, such as updating Form ADV for new disciplinary events of supervised persons reported on CRD
- Effective Compliance Programs – OCIE observed that many advisers did not adopt and implement compliance policies and procedures that address the risks associated with hiring and employing individuals with prior disciplinary histories.
- Whether the supervised persons’ self-attestations regarding disciplinary events completely and accurately described those events
- Whether the supervised persons’ self-attestations that they were not the subject of reportable events or recent bankruptcies was in fact the case
Additionally, when reviewing firm-wide practices, OCIE observed other issues not necessarily attributed directly to firms’ hiring and supervision of individuals with disciplinary histories. These issues include:
- Supervision – OCIE observed that many advisers did not adequately supervise or set appropriate standards of business conduct for their supervised persons.
- Oversight – OCIE observed that many advisers did not confirm that supervised persons identified as responsible for performing certain compliance policies and procedures were executing their duties, as prescribed.
- In some instances, the duties included key regulatory and business responsibilities for advisers managing investor assets, like monitoring the appropriateness of client account types and maintaining true, accurate, and current books and records.
- Compliance Policies and Procedures – OCIE observed that several advisers had adopted policies and procedures that were inconsistent with their actual business practices and disclosures.
- Annual Compliance Reviews – OCIE observed that advisers’ annual reviews were insufficient because the firms did not take steps to adequately document the reviews and appropriately assess the risk areas applicable to the firms, or identify certain risks at all. (Click here to see how RIA Compliance Consultants can assist with the documentation of Annual Compliance Reviews.)
- Disclosure of Conflicts of Interest – OCIE observed that several advisers had undisclosed compensation arrangements, which resulted in conflicts of interests that could have impacted the impartiality of the advice the supervised persons gave to their clients. Investment advisers did not disclose:
- Forgivable loans were made to the advisers or their supervised persons, the terms of which were contingent upon certain client-based incentives that may have unduly influenced the investment decision-making process, resulted in higher fees and expenses for the affected clients, or both
- Supervised persons were required to incur all transaction-based charges associated with executing client transactions, which created incentives for the supervised persons to trade less frequently on behalf of their clients
To help address these deficiencies OCIE laid out the following examples of some actions investment advisers can take.
- Adopting written policies and procedures that specifically address what must occur prior to hiring supervised persons that have reported to the adviser disciplinary events.
- Enhancing due diligence practices associated with hiring supervised persons to identify disciplinary events.
- Establishing heightened supervision practices when overseeing supervised persons with certain disciplinary histories.
- Adopting written policies and procedures addressing client complaints related to supervised persons.
- Including oversight of persons operating out of remote offices in compliance and supervisory programs.
RIA Compliance Consultants encourages investment advisers to consider the risks presented by hiring and employing supervised persons with disciplinary histories and adopt policies and procedures to address those risks and disclosure requirements. We encourage investment advisers to attend our upcoming conference in Omaha, NE on September 11 – 12, 2019, where we will discuss supervising IARs during our session “Putting the ‘Super’ In Supervision” and where we will also discuss conflicts of interest disclosures during our session “Disclose Disclose Disclose (and Mitigate)!” Click here to view our full conference agenda.
If your investment adviser firm is an existing client of RIA Compliance Consultants and has questions about supervised persons with disciplinary histories or needs help addressing any of the supervisory issues identified in the Risk Alert, we encourage you to speak with your compliance consultant or, if you are not a an existing client, of RIA Compliance Consultants click here to set up an introductory call with one of our Senior Compliance Consultants.