OCIE Releases Risk Alert on Compliance Issues Related to Investment Advisers’ Supervised Persons With Disciplinary History

On July 23, the SEC’s Office of Compliance Inspections and Examinations (OCIE) released a risk alert setting forth compliance issues that OCIE had observed during its series of examinations of SEC-registered investment advisers (RIAs) that previously employed or currently employ supervised persons with a disciplinary history. OCIE detected deficiencies in nearly all of the examined RIAs related to compliance, disclosure of conflicts of interest and supervision.

In 2017, OCIE conducted more than 50 examinations of RIAs collectively managing approximately $50 billion in assets for nearly 220,000 clients (most of them retail investors). OCIE focused specifically on RIAs’ practices in certain areas, including the design of appropriate compliance programs and implementation of supervisory oversight practices; the fairness and accuracy of disclosures in public statements and documents; and the identification, remediation and disclosure of conflicts of interest.

OCIE observed that:

• Nearly half of the examined RIAs omitted material disclosures regarding their supervised persons’ disciplinary history or their own; disclosed incomplete, confusing or misleading information regarding disciplinary events; and failed to timely update their Form ADV and provide their clients with updated disclosure documents.
  
  
• Many of the examined RIAs failed to adopt and implement compliance policies and procedures addressing the risks associated with hiring and employing individuals with a prior disciplinary history (for example, they were not able to identify whether the supervised persons’ self-attestations completely and accurately described disciplinary events or whether such supervised persons were not actually subject to reportable events or bankruptcies).

Additionally, OCIE detected issues that were not necessarily attributable to the RIAs’ hiring and supervision of supervised persons with a disciplinary history. OCIE observed that:

• A large number of the examined RIAs’ policies and procedures did not sufficiently describe the responsibilities of and did not clearly outline the expectations for their supervised persons, including oversight of fee disclosures, advertising material preparation and remote working arrangements.
  
  
• Many of the examined RIAs did not confirm that their supervised persons responsible for performing certain compliance policies and procedures were actually executing their duties, including key regulatory and business responsibilities such as monitoring the appropriateness of client account types and maintaining true and accurate financial books and records.
  
  
• Several RIAs had adopted policies and procedures that were inconsistent with their actual business practices and disclosures, including those related to commissions, fees and expenses.
  
  
• Certain RIAs’ annual compliance reviews were not adequately documented, and firm-related risks were not appropriately assessed or even identified at all.
  
  
• Several RIAs had undisclosed conflicts of interest, some of which related to compensation arrangements. For example, OCIE found that forgivable loans were made to certain persons that would be forgiven upon certain client-based incentives being met, thereby potentially causing those persons to increase the fees and/or expenses borne by the clients.

Finally, OCIE suggested several ways for RIAs to improve their regulatory compliance when employing supervised persons with a prior disciplinary history, such as adopting written policies and procedures clearly addressing what to do before hiring such individuals, and adopting policies and procedures that address client complaints related to their supervised persons; enhancing due diligence practices as part of the hiring process for such individuals (for example, performing thorough background checks, conducting internet and social media searches, fingerprinting, reviewing new hires’ Form U5, and checking the CRD/IARD system at the time of hire as well as at a later time in order to cross-check disciplinary information, etc.); and strengthening the oversight of supervised persons with a known disciplinary history and of those working remotely.