On November 9 2020, the Office of Compliance Inspections and Examinations (“OCIE”) of the U.S. Securities and Exchange Commission (“SEC”) released a Risk Alert about its assessment of the compliance practices of SEC-registered investment advisers that have multiple branch offices. In its Risk Alert, the SEC noted that its Multi-Branch Initiative (“Initiative”) focused on investment advisers practices relating to compliance programs and supervision, with a particular focus on the Code of Ethics Rule, Custody Rule, and fiduciary obligations relating to fees, expenses, and advertising. The SEC also evaluated how supervised persons at branch locations provided investment advice, focusing on oversight of investment recommendations, management and disclosure of conflicts of interest, and allocation of investment opportunities.
The Risk Alert discusses common deficiencies found as part of the Initiative, along with examples of practices that some investment adviser firms have adopted to mitigate risk and increase compliance when managing multiple branch offices. Click here to read the SEC’s Risk Alert for Multiple Branch Offices.
Compliance and Supervision
The majority of investment advisers examined during the Initiative were cited for at least one compliance violation, and more than half were discovered to have compliance policies and procedures that were out of date, inconsistently applied across branches, or unenforced. The most common deficiencies were related to custody and fee billing practices.
- Custody of client assets. OCIE observed a variety of practices which gave rise to custody. Many of these practices, such as commingling assets, acting as trustee to client assets, receiving checks for clients, and having overbroad disbursement authority over client assets, have been previously subject to comment and clarification by the SEC.
- Fees and expenses. OCIE noted failures to identify and remediate undisclosed fees charged to clients, as well as failures to enforce policies and procedures related to fees which led to clients being overcharged. Discrepancies arose from incorrect calculation of fee tiers or valuations, inconsistent fee reimbursements (such as for 12b-1 fees or pro rata refunds on termination of services), and charging fees differently than stated in the client agreement (e.g., a different rate or charging fees on excluded assets).
- Oversight and supervision of supervised persons. OCIE observed inadequate supervision that resulted in failures to disclose disciplinary events of supervised persons, failure to detect and remediate portfolio management that was not in the client’s best interest, and failures of best execution. These deficiencies were most common when investment adviser firms were supervising high-risk individuals located at branch offices.
- Advertising. Problematic advertisements were common. OCIE noted instances where advertisements used superlatives or unsupported claims, performance presentations that omitted material disclosures, inaccurate statements regarding the professional experience and/or credentials of the firm or its supervised persons, and third-party rankings or awards that omitted material facts.
- Code of Ethics. OCIE observed that some investment adviser firms failed to enforce personal securities transactions policies and procedures, to properly identify access persons, or to include all required provisions in the firm’s Codes of Ethics.
More than half of investment advisers examined during the Initiative were cited for failures relating to portfolio management.
Portfolio management. OCIE observed investment advisers who failed to adequately supervise branch conduct resulting in improper trading and reduced client returns, including the following:
- Oversight of, or reasonable basis for, investment recommendations, including mutual fund share class selection/disclosures, wrap fee program issues, and rebalancing issues.
- Conflicts of interest disclosures, including financial incentives for the firm or its representatives to recommend certain investments.
- Trading and allocation of investment opportunities, including deficient best execution documentation, undisclosed principal transactions, and block trading allocations that disproportionately disadvantaged clients compared to personal accounts belonging to supervised persons.
Additional Staff Observations on Compliance Practices
OCIE noted the following example practices which investment advisers might consider when implementing a compliance program for multiple branch offices.
“Advisers adopted and implemented written compliance policies and procedures that: (1) were applicable to all office locations and all supervised persons – regardless of whether these individuals were independent contractors or employees of the adviser; (2) include unique aspects associated with individual branch offices; and (3) specifically address compliance practices necessary for effective branch office oversight.
- Uniform policies and procedures regarding main office oversight for monitoring and approving advertising
- Centralized, uniform processes to manage client fee billing.
- Centralized processes for monitoring and approving personal trading activities for all supervised persons located in all office locations.
- Uniform portfolio management policies and procedures, portfolio management systems, or both, across all office locations.
Advisers performed compliance testing or periodic reviews of key activities at all branch offices at least annually, with some firms conducting reviews more frequently:
- Validating that branch offices undertook compliance or supervision reviews of their portfolio management decisions, both initially and on an on-going basis.
- Designating individuals within branch offices to provide portfolio management monitoring, primarily to assess whether investment recommendations were consistent with clients’ investment objectives or recommendations.
- Consolidating the trading activities occurring within branch offices into the advisers’ overall testing practices.
- Conducting compliance reviews that did not solely rely on self-reporting by personnel.
Advisers established compliance policies and procedures to check for prior disciplinary events when hiring supervised persons and periodically confirming the accuracy of disclosure regarding such information
Advisers required compliance training for branch office employees.”
Investment adviser firms with branch offices must take special care to ensure that branch offices, particularly geographically dispersed offices, are adequately supervised and maintain effective communication with the main office. The SEC has noted that investment adviser firms that fail to implement compliance testing and monitoring of branch offices may be unaware that their policies and procedures for branch offices are ineffective or inadequate. RIA Compliance Consultants encourages investment advisers that have multiple branch offices to closely review the SEC’s Risk Alert in light of their current compliance policies and procedures as well as the investment adviser’s actual practices. RIA Compliance Consultants has developed several tools to assist an investment adviser firm with branch office supervision, including the Branch Office Review – IA Checklist, Branch Office – Checklist for Office Sharing with Unaffiliated, 3rd Party, Branch Office – Adding New Office Location Checklist, and two recorded webinars: Investment Adviser Branch Office Supervision & Supervision of Representatives with Past Disciplinary Histories, and Conducting an Annual Compliance Review – Session 4 – Supervision, Branch Offices, Outside Business Activities.
If your investment adviser firm is an existing client of RIA Compliance Consultants and would like assistance in reviewing your policies and procedures or practices relating to branch offices, we encourage you to speak with your compliance consultant. Or, if you are not an existing client of RIA Compliance Consultants, click here to set up an introductory call with our Business Development Team.