More On Legal & Compliancefrom The Advisor's Professional Library
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
- Trading Practices and Errors When SEC-registered investment advisors conduct annual audits of firm policies and procedures, they should pay close attention to trading practices. Though usually not required to, state-registered advisors should look at their trading practices and revise policies that do not fully protect clients.
When the talk turns to Securities and Exchange Commission examinations and inspections, advisors tend to take notice. How can they do otherwise? The SEC conducted more than 1,530 advisor exams last year, 11% of which led to enforcement referrals, and expects to keep up the volume established in the past four or five years even while it is shifting focus, according to recent comments by SEC officials.
First, there may be a little more restraint ahead when it comes to sweep exams. The SEC's Office of Compliance Inspections and Examinations (OCIE) will now give the five commissioners input on planned sweep exams, or at least alert them to the sweeps in an effort at improved coordination, according to Commissioner Paul Atkins. Atkins, who addressed the Investment Adviser Association's (IAA) compliance best practices conference in Washington February 28, spoke with disdain of some SEC staff amassing large penalties the way that some "athletes collect trophies."
Atkins also remarked that the SEC should not be overzealous and penalize advisors retroactively for problems that took place before a new rule has taken effect, nor set regulatory policy during the exam process.
The mandatory registration of hedge funds may strain the OCIE staff. The new requirement "vastly expands the workload of the SEC," Atkins said, and can "greatly impair" efforts to examine other investment advisors who are more important to monitor.
In comments to reporters after his speech, Atkins acknowledged that the inspection staff might be running triage to go where it was most needed because the hedge fund registrants would divert examiners from other registered advisers and mutual funds.
That doesn't mean advisors should take a "safety in numbers" approach, Atkins warned.
Part of the impetus to think about the role of the 11-year-old OCIE and its feared tool of sweep exams, which grew to life during the mutual fund scandals in years past, comes from legislation encapsulated in the Compliance, Examinations, and Inspections Restructuring Act of 2005.
The bill (H.R. 4618), aims to eradicate the powerful inspection office as a separate entity and reintegrate it back into the various policymaking divisions. Such a move might improve interaction between those who form policy and those on the front lines of the exam, according to Atkins, and perhaps create better synergies internally. On the other hand, a stand-alone OCIE might result in more moderate measures, Atkins said, wisely hedging his response.
For the future, expect a more "balanced" approach to exams, said OCIE Chief Counsel John Walsh, speaking at the same conference.
Last year, 52% of OCIE exams were regular exams, and 48% were for cause or other reasons, and Walsh expects that to continue, noting the word "sweep," is over-used. In fact, risk-based sweeps are a declining part of the exam program, Walsh said, because "balance is the goal," and the office is looking for emerging risks.
OCIE will be pursing a relatively new concept called statistical exams targeted toward lower-risk advisors, using statistics to select firms for forensic testing, and will also be rolling out a pilot for very large institutions whereby a monitoring team or a clearing house oversees the various investigations of that institution going on around the country.
Meanwhile, the SEC is reviewing comments to its proposed soft dollar disclosure guidance even as questions linger on which research and brokerage services fall under the safe harbor created for the use of soft dollars.
Under the SEC's October 19 guidance, the service or product must first be eligible as "brokerage" or "research" under the safe harbor, must provide lawful and appropriate assistance in the investment decision, and the money manager must make a good-faith determination that the resulting client commissions are reasonable.
But technology and communication services, such as software and e-mail services, are leaving some people baffled. The SEC noted in its release that developments in technology have led to difficulties in applying client commissions and that money managers have taken an "overbroad" view of what falls under the safe harbor.
Jo Anne Swindler, assistant director in the SEC's division of market regulation, couldn't definitely answer whether a Bloomberg terminal would fall under the safe harbor or not during a question-and-answer period at the conference.
Analytical software is research under the safe harbor, so a Reuters or Bloomberg terminal is likely to also unless "there are delivery services" involved, she said. Swindler was also not definitive on the safe harbor standing of "free services," such as free Web site services or a free Bloomberg terminal and whether they should be separately valued. "I think it's an issue we are going to be looking at," she said.
The issue the SEC has received the most comments on is commission sharing, Swindler said, an area that she expects the Commission "to pay extra attention to in the adopting release."
Anti-Money Laundering Requirement
Also at the conference, an SEC official all but gave notice that Treasury's Financial Crimes Enforcement Network (FinCEN) will definitely adopt a rule that requires certain investment advisors to adopt anti-money laundering (AML) programs. "FinCEN talks to us a lot," said Jamey Basham, branch chief in the SEC's Division of Investment Management.
OCIE hasn't drafted any exam guidance on this yet because there is no final rule, but there are certain steps advisors may want to take already in any AML program, he said. Basham suggested advisors observe their customers' ways of doing business and the transaction and document aspects of their AML program.--Elizabeth Festa