The duty of an investment advisor to put a client’s interest before their own as a fiduciary permeates all aspects of operations of an advisory firm, but are most pronounced when managing client portfolios and engaging in securities transactions. When an investment advisory representative (“IAR”) is considering a trade for a client, they must also consider how that decision impacts their overall client base so that they can ensure the decisions made are done for all clients fairly and equally. As a result, areas of our operations where we are managing client portfolios must go through some aspect of compliance consideration in order to ensure that the proper process or controls are in place to address compliance risks.
Portfolio Management In a Nutshell
When managing securities for clients of your advisory firm, it is important to consider the compliance issues related to the group of all clients in addition to the unique issues for each individual client. The services your firm offers and the tools that are used to accomplish operational goals can introduce compliance risks that need to be considered and supervised for potential violations and to document such supervision for your firm's books and records.
If your advisory firm allows clients to impose restrictions on the management of their portfolio, it is important to capture these restrictions and configure your tools or perform reviews to ensure they are not violated. For example, a client with a legacy share position from their prior employer may want to keep that position and restrict their advisor from selling it. The advisor would want to consider ways in which they could flag or restrict that position to ensure it is not accidentally traded during a rebalance of the client’s portfolio. As CCO, you may want to put together a list of account restrictions across your clients and review the individual accounts periodically in order to confirm the restrictions have been honored.
RIA firms are required to apply supervision to the investment decisions made for their clients to ensure related aspects of the fiduciary duty such as suitability, best execution, trade error management, engaging cash, rebalancing, trade restrictions, and other issues related to portfolio management are evaluated and analyzed for potential compliance violations. If an RIA firm is not applying proper supervision to their trade operations, this can lead to compliance violations, client complaints, and ultimately regulatory action. Since many aspects of an RIA firm’s portfolio management operations are unique, depending on the services, vendors, and affiliate or other third-party relationships they may have, CCOs will want to review those different tools and relationships used by Supervised Persons of the RIA firm and have an understanding of how they are used in order to properly apply that supervision and compliance review.
Through the Regulator’s Eyes
With regard to portfolio management at your RIA firm, regulators expect that you fully understand and can speak to compliance issues relating to your operational tools and services, including third-parties that may be providing services to your firm or to your clients. By doing so, you can demonstrate that as CCO you are providing adequate supervision to the activities of your RIA firm, and overall that the firm is upholding its fiduciary duty to its clients. You are expected to have an understanding of how compliance impacts your firm’s portfolio management operations, speak to the issues involved, and maintain proper books and records that demonstrate that you are meeting these requirements in accordance with the Adviser’s Act.
CCO Best Practices
CCOs of RIAs have an obligation to understand, supervise and document the firm’s operations as they relate to compliance activities, depending on your tools and services provided. The CCO should review their portfolio management policies and procedures in their compliance program and speak to the following issues:
- Are clients permitted to impose trading restrictions?
- How are the restrictions captured to ensure they are respected?
- Is there a way to restrict in the system?
- What is the frequency of review of client accounts with restrictions?
- Sub-advisors
- Does your firm outsource investment management to another advisor?
- Are you performing due diligence on the sub-advisor before engaging?
- Are you providing ongoing supervision to the client assets being managed by the sub-advisor?
- Do you have books and records to support your answers?
- Automated order management systems
- Do you use a system to automatically execute trades based on pre-configured settings?
- Are you reviewing exception reports of the automated system?
- Are you providing ongoing supervision to the client assets being utilized in the automated system?
- Do you have books and records to support your answers?
- Other potential areas of concern
- Cash balances
- Portfolio rebalancing
- Brokerage recommendation or discretion
The AdvisorAssist CCO Series is a collection of blog posts that cover each of the elements of your RIA's compliance program. Each post will provide an overview of one compliance topic, including our insights on how regulators view each topic as well as some practical steps to help Chief Compliance Officers address this topic. As always, we would welcome your comments and thoughts.
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