SEC Amends Rule 206(4)-7 Requiring Documentation of Annual Review

SEC Is Now Requiring An Investment Adviser to Document Annual Compliance Review In Writing

August 25, 2023


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Regulatory Alert

The United States Securities and Exchange Commission (“SEC”) has adopted an amendment to Rule 206(4)-7 under the Investment Advisers Act of 1940 as amended, which requires all SEC-registered investment advisers to document in writing the annual review of their compliance policies and procedures.

Requirement Prior to the Amendment

Before this rule amendment, investment advisers were required to review their compliance policies and procedures annually. However, there was no explicit requirement to document this review in writing. An investment adviser’s annual compliance review is intended to evaluate whether the compliance policies and procedures continued to work as designed and whether changes were needed to assure their continued effectiveness.

The Amendment: Written Documentation of Annual Review

The amendment to Rule 206(4)-7 establishes a written documentation requirement applicable to all advisers subject to the compliance rule. The written documentation must include a review of the adequacy of the compliance policies and procedures and the effectiveness of their implementation, conducted no less frequently than annually.

Flexibility in Documentation

The amended rule does not enumerate specific elements that a federally registered investment advisers must include in the written documentation of their annual compliance review. It is intended to be flexible, allowing investment advisers to continue using the review procedures they have developed and found most effective. Some investment advisers may choose to document the annual compliance review in various ways, such as a lengthy written report with supporting documentation, quarterly documentation aggregated at year-end, or a presentation to the board or another governing body. However, the Rule 206(4)-7 as amended does not specifically mandate a certification by the Chief Compliance Officer (“CCO”) or President/Chief Executive Officer of the investment adviser.

Reasons for Adopting the Amendment

Assessment of Compliance Matters: Written documentation may help investment advisers better assess whether they have considered any compliance matters that arose during the previous year, changes in business activities, and any changes to the Investment Advisers Act or other SEC rules and regulations that may suggest a need to revise policies and procedures.

Increased Visibility for the SEC: Without written documentation, the SEC examiners have limited visibility into an investment adviser’s compliance practices. The written document requirement will enable the SEC to determine if the investment adviser is regularly reviewing the adequacy of the policies and procedures.

Structured Framework: Clients and investors conducting due diligence may request written documentation of the annual review to assess whether the investment adviser applies a structured framework and rigor to its compliance program.

Already Widely Adopted Practice: SEC explained that some commenters noted that written documentation of the annual review has been widely adopted as a standard practice by investment advisers and would not have a large impact.

Attorney-Client Privilege and the Annual Compliance Review

Under the amended Rule 206(4)-7, the written documentation of the annual review is meant to be made available to the SEC. The final rule release specifically addresses the issue of attorney-client privilege of the annual compliance review, stating: “[t]he required written documentation of the annual review under the compliance rule is meant to be made available to the Commission and the Commission staff and therefore should promptly be produced upon request. Commission staff has observed improper claims of the attorney-client privilege, the work-product doctrine, or other similar protections over required.” The release explains further that “[a]ttempts to improperly shield from, or unnecessarily delay production of any non-privileged record is inconsistent with prompt production obligations and undermines Commission staff’s ability to conduct examinations.” See https://www.sec.gov/files/rules/final/2023/ia-6383.pdf at pages 307 – 308. These statements clarify that the written documentation of an SEC-registered investment adviser’s annual compliance review is expected to be produced upon request by the Commission. Investment advisers should be aware of this expectation and consult with legal professionals to understand the implications of this requirement in relation to attorney-client privilege.

Implementation and Compliance Date

The amendment to the SEC’s Rule 206(4)-7 requiring written documentation of the annual compliance review will be effective 60 days after published in the Federal Register.  (This amended rule was published in the Federal Register on September 14, 2023.) “Thus, whenever the adviser commences its review within the next 12 months after the compliance date, the review must be documented in writing.” See https://www.sec.gov/files/rules/final/2023/ia-6383.pdf at page 315. As a result, an SEC registered investment adviser’s compliance review commenced after November 13, 2023 should be documented in writing.

Takeaways

The amendment to Rule 206(4)-7 represents a significant step in standardizing the practice of documenting annual reviews of compliance policies and procedures. While many investment advisers already document this review in writing, the formal requirement emphasizes the importance of the annual compliance review process and enhances the SEC’s ability to oversee compliance practices. Investment advisers should consult with legal or compliance professionals to understand the specific implications of this amendment for their firms.

Related Resources

RIA Express – Compliance Review Tool

Annual Review – Spreadsheet for Risk Assessment, Supervision Chart and Assessment Log

CCO – Third-Party – Confirming Annual Review Completion

Branch Office Review – IA Checklist

SEC Release for Final Rule Documentation of Registered Investment Adviser Compliance Reviews at pages 302 – 308, 314 – 315 and 646

SEC Fact Sheet: Private Fund Adviser Reforms

SEC Requires RIAs to Complete Risk Assessment as Part of Annual Compliance Review (12/02/2020)

Repeat Compliance Program Deficiencies Result in SEC Enforcement Actions for Investment Advisers (11/05/2013)

Investment Advisers Must Review their Written Policies and Procedures at Least Annually (10/30/2013)

Disclosure

This regulatory alert is a brief summary which is general in nature and offered only for educational purposes. It should not be considered as a comprehensive review or analysis of this development. This communication is not intended to constitute compliance consulting advice or apply to any particular investment adviser firm’s specific situation without further analysis. This regulatory alert is not a safe harbor or a legal opinion. The reader should study the actual guidance, rule or enforcement action in detail and consult with his or her compliance professionals.  This information in this regulatory alert may become out of date.

Posted by Bryan Hill
Labels: Annual Review, Compliance Program, SEC
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