Due diligence can be defined as the level of judgment and care a reasonable person would take before entering into an agreement or transaction. As part of an effective compliance program investment advisers must conduct due diligence not only when selecting investments for clients but also when outsourcing services to third-party service providers. The importance of outside service provider due diligence was discussed as an examination focus area by the U.S. Securities and Exchange Commission (“SEC”) during their 2009 CCOutreach Regional Seminars. During the seminar, the SEC noted that “advisers should review each service provider’s overall compliance program for compliance with the federal securities laws and should ensure that service providers are complying with the firm’s specific policies and procedures.” During a routine examination, SEC examiners will “review an adviser’s disclosures, contracts with clients, and contracts with service providers to determine whether the services and reporting obligations are consistent with disclosures and that all obligations are adequately addressed and overseen by the adviser.”
Category Archives: SEC
Mid-sized investment adviser firms that did not register with one or more state securities regulators by the June 28, 2012, deadline are in danger of being de-registered by the U.S. Securities and Exchange Commission (SEC) as early as this week. However, the first wave of terminations may not occur until September according to a staff member from the SEC who spoke with one of our Senior Compliance Consultants earlier this year. Investment advisers that did not file an amendment to Form ADV Part 1 confirming their registration status by the March 31, 2012, deadline and/or have not filed a state registration application, if no longer SEC eligible; face the highest risk for untimely termination.
Due diligence needs to be an important component for any investment adviser compliance program. As we discussed earlier, due diligence should not be limited to recommending investments, but must also be employed when recommending or using third party service providers. In our opinion, one of the most important, if not the most important, outside service provider decisions made by investment advisers are the selection of a recommended broker/dealer. In fact, many investment advisers require clients to use a particular broker/dealer. However, far too many investment advisers fail to perform adequate due diligence on this important selection. We hear from many investment advisers that they fully understand broker/dealer best execution reviews are expected, but are not completed because of reasons such as (1) the broker/dealer they work with is large and reputable, (2) the investment adviser only selects mutual funds so best execution doesn’t matter or (3) the differences between broker/dealers are so slight that due diligence is unnecessary. Because of these reasons and others such as time and cost constraints, broker/dealer best execution reviews and due diligence is a matter often neglected by investment advisers.
State Registered Investment Advisers Should Expect Increase in Examinations After the Switch
June 21, 2012
As we have discussed in a previous newsletter article, investment advisers switching registration from the U.S. Securities and Exchange Commission (“SEC”) to state securities regulators are likely to see an increase in examinations. According to the North American Securities Administrators Association (“NASAA“), “firms switching to state regulation for the first time can expect thorough inspections generally on a more frequent basis than they may have experienced before.”
The National Association of Personal Financial Advisors (NAPFA) recently released a statement on the potential negative effects of H.R. 4624, the Investment Adviser Oversight Act of 2012, (Investment Adviser Oversight Act). NAPFA says this bill will “allow the foxes to run the henhouse.” NAPFA is alluding to the belief that if the bill is passed and a self-regulatory organization (SRO) is created for investment advisers, it will be the Financial Industry Regulatory Authority (FINRA).
Investment Advisers Should Make Sure They Can Back-Up Statements and Claims Made in Advertising
June 13, 2012
Investment advisers must be cautious when it comes to the statements and claims used in advertising and marketing materials and this does not just pertain to performance claims. Investment advisers must avoid all statements or claims that are unsubstantiated or that cannot be proven with material facts. Investment advisers registered with the U.S. Securities and Exchange Commission (“SEC”) must ensure that all advertising and marketing material complies with Rule 206(4)-1 under the Investment Advisers Act of 1940 (“Investment Advisers Act”). Many state investment adviser regulations follow similar regulatory guidelines as those outlined in Rule 206(4)-1. Under SEC Rule 206(4)-1(a)(5), investment advisers are expressly prohibited from publishing, circulating and distributing any advertisement, “which contains any untrue statement of a material fact, or which is otherwise false or misleading
H.R. 4624, the Investment Adviser Oversight Act of 2012, (“Investment Adviser Oversight Act”) proposes creating a self-regulatory organization (“SRO”) for investment advisers. Currently, the U.S. Securities and Exchange Commission (“SEC”) has primary oversight of federally registered investment advisers and state securities regulators have primary oversight of state-registered investment advisers. As a result of the Dodd–Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), state securities regulators have begun serving as the primary regulator for investment advisers with up to $100 million of assets under management. Those investment advisers with more than $100 million are regulated primarily by the SEC. The Investment Adviser Oversight Act, if passed, creates an SRO for all investment advisers to report to, including those at the state level. H.R. 4624 as it stands now would also require state securities regulators to report to an investment adviser SRO annually to make sure that the states are meeting standards.
GAO Report Finds SEC Oversight of FIRA Lacking & Critics Use Report Against FINRA as Potential Investment Adviser SRO
June 05, 2012
The U.S. Government Accountability Office (“GAO”) recently released a report on the U.S. Securities and Exchange Commission’s (“SEC”) oversight of the Financial Industry Regulatory Authority (“FINRA”). The report examined “how the SEC conducted oversight of FINRA and how it plans to enhance oversight in the future.”
With the deadline for “the Switch” approaching, investment advisors that are currently registered with the U.S. Securities and Exchange Commission (“SEC”) should conduct one final calculation of their assets under management (“AUM”) to ensure that their investment advisor remains eligible for SEC registration.
Marketing materials can be very helpful in attracting business for an investment advisor, but investment advisors should be aware of the regulatory requirements that apply to the use of marketing materials. Common issues with investment advisory marketing materials include using marketing materials that include testimonials (which investment advisors are generally prohibited from using); publishing past recommendations (without following the restrictions and disclosure requirements for publishing past recommendations); using language that makes promises or guarantees; and making untrue or misleading statements.
