The Office of Compliance Inspections and Examinations (OCIE) of the US Securities and Exchange Commission (SEC) issued a National Exam Program Risk Alert on 7 February 2017 (Risk Alert), highlighting the “five compliance topics most frequently identified in deficiency letters that were sent to SEC-registered investment advisers” in a sample of over 1,000 examinations during the prior two years. The deficiencies or weaknesses concerned requirements of the Investment Advisers Act of 1940 (Advisers Act) and rules thereunder related to: compliance, regulatory filings, custody, codes of ethics, and books and records.1 After identifying the topics, the Risk Alert provides examples of typical issues identified by examiners. The Risk Alert encourages advisers to review their compliance programs and states that “where appropriate, the staff referred examinations to the Division of Enforcement for further action.” The registered entities within OCIE’s oversight include more than 12,000 advisers with nearly $67 trillion in assets under management.2 In late 2016, OCIE’s then-director indicated that OCIE had bolstered its examination staff for advisers and investment companies by about 20% for fiscal 2017, and he referred to advisers as a fast-growing group of registrants that were not subject to a self-regulatory organization.3
Compliance Rule: Rule 206(4)-7
The Compliance Rule requires advisers to: adopt and implement written policies and procedures reasonably designed to prevent Advisers Act violations; annually review their policies and procedures for adequacy and effectiveness; and designate a Chief Compliance Officer to administer the compliance programme. In the Risk Alert, OCIE staff found the following issues:
Advisers are required to comply with certain obligations to make accurate and timely regulatory filings with the SEC, including: Forms ADV and PF, pursuant to Advisers Act Rule 204-1 and Rule 204(b)-1, respectively, and Form D (on behalf of private fund clients) pursuant to Rule 503 under Regulation D of the Securities Act of 1933.4 The staff found the following issues:
Custody Rule: Rule 206(4)-2
The Custody Rule sets forth requirements for advisers (or their “related persons”) that (1) hold, directly or indirectly, client cash or securities, or (2) have any authority to obtain possession thereof. The Custody Rule is designed to protect client assets from unlawful activities or financial troubles of an adviser. The staff found the following issues:
Code of Ethics Rule: Rule 204A-1
The Code of Ethics Rule requires advisers to adopt and maintain a code of ethics that subjects all supervised persons to a required standard of business conduct; requires “access persons” to make periodic reports of their personal securities holdings and transactions, and to obtain pre-approval for certain investments; and requires advisers to provide each supervised person with, and obtain an acknowledgment of receipt of, the adviser’s code of ethics. Further, advisers must provide certain disclosures related to the code of ethics in their Form ADV Part 2A (brochure). The staff found the following issues:
Books and Records Rule: Rule 204-2
The Books and Records Rule requires advisers to make and maintain certain books and records. Staff specified the following issues:
Implications for advisers
The Risk Alert notes remedial measures taken by advisers, including further improvements to their written compliance programs, alterations to their practices to correspond with their compliance manuals, and dedication of additional resources to the compliance function. The Risk Alert also notes that some of these deficiencies resulted in referrals to the Division of Enforcement. The Risk Alert serves as a reminder that investment advisers’ compliance programmes are evergreen and require constant attention and review, and that the foundational elements and the details matter.
1. The Five Most Frequent Compliance Topics Identified in OCIE Examinations of Investment Advisers
2. Examination Priorities for 2017 (12 January 2017)
3. OCIE Director Marc Wyatt, Inside the National Exam Program in 2016 (17 October 2016)
4. Form ADV is the form pursuant to which advisers register with the SEC; it must be updated at least annually (within 90 days of the end of an adviser’s fiscal year) and amended more frequently upon changes to certain information. Form PF must be filed by registered advisers that manage one or more private funds, and that have at least $150 million of private fund assets under management (with filing dates dependent on the adviser’s business and size). Form D is typically filed by advisers on behalf of their private fund clients (generally no later than 15 calendar days after the first sale of securities in the offering of a private fund).