The Office of Compliance Inspections and Examinations (“OCIE”) issued a Risk Alert based on the examinations of over 50 advisers in 2017 as part of this Initiative. The majority of the advisers were retail advisers identified for examination through a review of information about disciplinary events and other legal actions, including those not required to be reported on Form ADV such as private civil actions. The Supervision Initiative focused on certain areas, including:
- Compliance programs and supervisory oversight practices.
- Conflicts of interest.
The examinations focused on the supervisory practices firm-wide rather than solely as related to individuals with prior disciplinary histories. The reason given for this was due to the importance supervisory practices have in setting a strong “tone at the top” and compliance culture.
Nearly all examined advisers received deficiency letters. Some of the observations related to advisers’ oversight consist of:
- Full and fair disclosure – inadequate information
regarding disciplinary events:
- Omitting material disclosures regarding disciplinary histories of supervised persons or the adviser itself, often as a result of relying on the supervised persons to self-report about their required disclosures.
- Incomplete, confusing or misleading information about disciplinary events, such as, number of events, date for each event, allegations or whether the supervised persons were found to be at fault (i.e., whether fines, judgments or awards, or other disciplinary sanctions were imposed).
- Updating and delivering disclosure documents to clients such as Form ADV were not timely.
- Effective compliance programs – advisers did not
adopt and implement compliance policies and procedures addressing the risks
associated with hiring and employing individuals with prior disciplinary
histories. For example, advisers did not have processes to identify:
- Whether supervised persons’ self-attestations regarding disciplinary events completely and accurately described the events.
- Whether the supervised persons’ self-attestations that they were not the subject of reportable events or recent bankruptcies was in fact the case. For example, some reported incorrectly to the adviser that they were not the subject of any reportable events during the reporting period or did not report information regarding recent bankruptcies.
OCIE also included deficiencies observed that were related to supervision but not directly attributed to the supervision of individuals with disciplinary histories.
Compliance and Supervision
– many advisers’ policies and procedures did not sufficiently document the
responsibilities of supervised persons or clearly outline the expectations.
Examples include practices where the adviser did not:
- Oversee whether fees charged by supervised persons were disclosed or assess whether services clients paid for were performed.
- Have advertising policies and procedures that provided enough guidance to supervised persons who prepared their own advertising materials and websites.
- Review activities of supervised persons working from remote locations as part of its monitoring activities.
– many advisers did not confirm that supervised persons identified as
responsible for certain compliance policies and procedures were executing their
assigned duties or did not document that these duties were performed, such as:
- Monitor the appropriateness of client account types.
- Maintain true, accurate, and current books and records, including those necessary to provide investment supervisory or management services to clients, to determine the financial standing of the firm, or to identify individuals with access to sensitive information.
- Compliance policies and procedures – several advisers adopted policies and procedures that were inconsistent with their actual business practices and disclosures, with the most frequently cited being those addressing commissions, fees, and expenses.
- Annual compliance reviews – 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.
Disclosures of Conflicts of Interest
arrangements – several advisers had undisclosed compensation arrangements
resulting in conflicts of interests, such as:
- Forgivable loans made to the advisers or their supervised persons, the terms of which were contingent upon certain client-based incentives that may have 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.
Ways to Improve Compliance
Advisers that hire or employ supervised persons with disciplinary histories may want to consider, among other things:
- Adopting written policies and procedures that specifically address what must occur prior to hiring supervised persons that have reported to the adviser disciplinary events such as requiring investigations of disciplinary events and ascertaining whether barred individuals were eligible to reapply for their licenses.
due diligence practices associated with hiring supervised persons to identify
disciplinary events including background checks, internet and social media
searches, fingerprinting, using third parties to research potential new hires,
contacting personal references and verifying educational claims. Additional
- Requesting that potential new hires provide copies of their Form U5s, when applicable.
- Reviewing new hires’ Form U5 filings 30 or more days after they are hired, when applicable, to help identify termination notices the new hire did not disclose that were filed after the hiring decision.
- Checking CRD/IARD for supervised persons’ filings and re-checking the filing information after a designated period of time, such as three months later.
- Establishing heightened supervision practices when overseeing supervised persons with certain disciplinary histories and addressing risks associated with them.
- 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, particularly when supervised persons with disciplinary histories are located in branch or remote offices.
OCIE encourages advisers, to consider risks presented by, and disclosure requirements triggered by, the hiring and employing of supervised persons with disciplinary histories, and adopt policies and procedures to address those risks and disclosure requirements. Advisers should review their practices, as well as policies and procedures and consider ways to improve their supervisory practices and compliance programs.