Client Newsletter – November 2016
Risky Business and Employees Can Put RIAs on SEC’s Radar
When the SEC’s Office of Compliance Inspections
and Examinations (“OCIE”) announced its priorities
for 2016, the Commission warned that higher-risk
Registered Investment Advisers (“RIAs”) were more
likely to be examined. Focusing on high-risk firms
enables the SEC and state securities regulators to
make the most effective use of their resources.
Firms that pose the greatest threat to retail
investors and individuals saving for retirement are
likely to be on the SEC’s radar.
A firm’s business model, as well as deficiencies
found during prior exams, increase the odds that an
RIA will be examined. Tips and complaints to
regulators will also elevate an RIA’s risk profile. In
addition, the SEC’s recent supervision initiative
warned that RIAs employing representatives with
disciplinary histories are viewed as high-risk firms
and are likely to be examined.
RIAs that employ individuals with a disciplinary
history are riskier
In its Examination Priorities for 2016 published on
January 11, 2016, OCIE explained how risk
dovetails with the examination process:
Since our examination program is risk-based, we
are always striving to detect risks across those
industries and within those firms that we oversee.
In all of our examination initiatives, including
those highlighted in this section, we utilize data
and intelligence from our own examinations, as
well as from regulatory filings, to identify
registrants that appear to have elevated risk
profiles.
OCIE makes use of data analytics to measure an
RIA’s risk profile.
OCIE warned RIAs and broker-dealers that the
SEC will continue to track recidivist representatives
and the firms that employ them. In particular, OCIE
will assess the compliance oversight and controls
of RIAs that hire individuals who were previously
disciplined or barred from a broker-dealer.
Risk Alert reaffirms OCIE’s focus on employees
and supervised persons with a bad track record
In case investment advisers forgot about the SEC’s
2016 priorities, OCIE published a Risk Alert which
announced its intent to conduct examinations of
RIAs that employ or enter into contracts with
individuals who have a history of disciplinary
“Focusing on high-risk firms enables the SEC
and state securities regulators to make the most
effective use of their resources.”
events. OCIE’s examinations of those firms will
measure the effectiveness of the RIA’s compliance
programs, supervisory oversight, and disclosures to
clients and prospects. The September 12, 2016
Risk Alert can be found at
https://www.sec.gov/ocie/announcement/ocie-2016risk-alert-supervision-registered-investmentadvisers.pdf.
OCIE’s supervision initiative is based upon the
belief that individuals with a disciplinary history
present a higher risk of future misconduct that
might cause harm to investors. It can be argued
that OCIE’s goal is to dissuade RIAs from hiring
Investment Adviser Representatives (“IARs”) who
have been disciplined in the past. Another objective
of the supervision initiative is to encourage RIAs to
implement heightened supervision of previouslydisciplined supervised persons.
OCIE’s Risk Alert applies to more than just IARs.
The Risk Alert’s definition of “employees” and
“supervised persons” includes principals and
officers of the firm, as well as other individuals who
perform services on behalf of the RIA. Clerical
employees are excluded from the definition. It does
not matter if the supervised persons are employees
of the RIA or independent contractors.
Client Newsletter: Risky Business and
Employees Can Put RIAs on SEC’s Radar
November 2016, Page 2
Risk areas on OCIE’s radar as part of its
supervision initiative
“OCIE’s supervision initiative is based upon the
belief that individuals with a disciplinary history
present a higher risk of future misconduct that
might cause harm to investors.”
RIAs that hire individuals with a history of
disciplinary events will face scrutiny in the following
risk areas:
Compliance Program. Rule 206(4)-7 under the
Investment Advisers Act of 1940 requires RIAs to
adopt and implement written policies and
procedures that are reasonably designed to prevent
violations of the securities laws. There must be
specific policies and procedures to mitigate the risk
of harm resulting from hiring persons with a poor
disciplinary record. Examiners will review an RIA’s
hiring processes, reporting, supervisory practices,
and complaint handling process, to ensure that the
firm is committed to operating compliantly.
Disclosures. RIAs owe a fiduciary duty to make full
and fair disclosure of all material facts. Examiners
are very likely to analyze RIAs’ practices related to
their disclosures of regulatory or disciplinary
infractions. They will scrutinize the accuracy,
adequacy, and effectiveness of those disclosures.
Conflicts of Interests. RIAs must make full
disclosure of all material conflicts of interest.
Examiners will be looking closely at conflicts of
interest that pertain to financial arrangements
involving supervised persons who have been
disciplined in the past.
Marketing. Obviously, RIAs must comply with the
advertising rule. Examiners will review
advertisements, including websites and social
media, to identify conflicts of interest or risks
triggered by supervised persons with a history of
disciplinary events in their past.
Although investment advisers should not live in fear
of compliance examinations, they are more likely to
be examined if they hire persons who are viewed
as a threat to investors.
Conclusion
The SEC and other securities regulators are always
concerned about recidivist violations by the firm
and its associated persons. A firm with prior
compliance problems is viewed as a higher risk
than other RIAs. Similarly, RIAs that hire
previously-disciplined IARs are considered to be a
higher risk and are likely candidates to be
examined. RIAs should implement stronger
supervisory procedures if they currently employ or
plan to hire IARs with a history of disciplinary
events. For more information about the hiring of
IARs, check out the NCS Regulatory Compliance
article entitled “Onboarding and Compliance for
Newly Registered Investment Advisors,” which is
located at
https://www.ncsonline.com/wp/onboarding-andcompliance-for-newly-registered-investmentadvisors/#more-4130.
An underlying message of OCIE’s supervision
initiative is that regulators are wary of firms that hire
representatives who have been in trouble in the
past. They may be concerned that an RIA is not
committed to fulfilling its fiduciary obligations to
clients. The initiative encourages firms to hire
individuals with clean disciplinary records.
Examiners will look at more than just the
supervision of the representative. According to the
Risk Alert, “Examinations will assess whether
registered advisers have implemented policies and
procedures specific to the risks presented by
employees with disciplinary history, focusing on the
compliance cultures and tone at the top of the
examined advisers.” Questionable hiring practices
undermine a firm’s ability to create a culture of
compliance.
The SEC has increased the number of RIA
examiners by twenty percent and is examining
advisory firms more frequently. The Commission
Client Newsletter: Risky Business and
Employees Can Put RIAs on SEC’s Radar
November 2016, Page 3
has hired more RIA examiners and reallocated
some members of its broker-dealer examination
staff to advisory firm exams. As the number of
examiners increase, more RIAs are likely to find
themselves on the SEC’s radar.
Les Abromovitz can be reached at NCS Regulatory
Compliance by calling 561-570-1813 or by e-mailing him
at [email protected]
Les is the author of THE INVESTMENT ADVISOR’S
COMPLIANCE GUIDE, which was published by the
National Underwriter Company, a division of ALM.