SEC Releases Risk Alert on Investment Adviser Exams

Last week, the SEC’s Office of Compliance Inspections and Examinations released a Risk Alert announcing an upcoming examination initiative that focuses on the supervisory practices of SEC-registered investment advisers and how they monitor advisory personnel in disparate branch locations.

In recent years, the OCIE has observed an apparent increase in the use of investment advisers employing a business model with numerous branch offices and operations geographically dispersed from the adviser’s principal or main office. By using this branch office model, unique risks and challenges have taken place, particularly as they relate to the design and implementation of their compliance program.

Accordingly, the OCIE is launching a Multi-Branch Adviser Initiative to examine investment advisers operating out of multiple branch offices to determine whether they are in compliance with federal securities laws in light of the additional and unique risks that arise as a result of this operational style.

The OCIE will be auditing the following risk areas:

Compliance Programs

The staff will evaluate the design and effectiveness of an adviser’s compliance program with respect to its oversight of advisory services provided at its branch offices. In particular, through interviews and the review of advisory records, the staff will assess, among other things, the:

  • Implementation of policies and procedures in the main and branch offices;
  • Supervision structure, including an assessment of how such supervision is tailored to the unique risks in particular branches;
  • Role and empowerment of compliance personnel charged with overseeing branch offices, including their level of access to documents and relevant information; and
  • Accuracy of information on the adviser’s filings regarding branch offices, including Form ADV, as compared to actual practices.

In addition, the staff may focus attention, based on the particular business activities of an examined adviser, on assessing compliance and testing controls in one or more of the following risk areas:

  • The adviser’s calculation of fees and other expenses, including the effectiveness of controls over the billing and invoicing processes and communications with clients;
  • Controls over advertisements, such as the adviser’s process for reviewing and approving advertisements, particularly those created or disseminated by its branch offices;
  • The implementation of the adviser’s code of ethics, including oversight and monitoring of personal securities transactions and whether advisers have properly identified access persons at branch offices;
  • Compliance with the Custody Rule, including controls related to the identification of accounts over which the adviser maintains custody and the involvement of branch office personnel in making such determinations.

Investment Recommendations

As a fiduciary, an investment adviser has an obligation to act in the best interests of its advisory clients and to identify and disclose any material conflict of interest. The staff will review the process by which investment advice, including the formulation of investment recommendations and the management of client portfolios, is provided to advisory clients from supervised persons located in branch offices. This review will include:

  • Supervision and review of investment recommendations made to clients within specific branch offices and across branch offices, including processes and controls regarding investment authority, suitability of the investment advice, and any due diligence that the adviser has told clients is undertaken with respect to investments.
  • Identification, management, and disclosure of conflicts of interest that arise through branch office activities and personnel, including conflicts arising from various compensation arrangements and supervised persons’ outside business activities.
  • Allocation of investment opportunities among client accounts, including how branch offices’ trading activity is monitored and what disclosures are made to clients regarding trade allocation.

To read the complete Risk Alert, click here.