Observations from OCIE’s Examinations of Investment Advisers: Supervision, Compliance and Multiple Branch Offices

On November 9th the Office of Compliance Inspections and Examinations (“OCIE”) distributed its latest Risk Alert. The focus of this Risk Alert related to Supervision, Compliance, and Multiple Branch Offices. Risk Alerts result from the SEC’s OCIE conducting Advisor examinations. The purpose of alerts are to provide guidance to Advisors regarding deficiencies identified through their examinations with the goal of assisting Advisors to ensure their policies and procedures are effective and appropriate given the nature of the deficiency.

Compliance and Supervision

Compliance Programs: The OCIE noted that with respect to their Compliance Programs “the vast majority of the examined advisers were cited for at least one deficiency related to the Compliance Rule.” This included:

• Inaccurate policies: outdated information

• Policies not being followed: not applying policies to all branches

• Inadequate implementation: not receiving records required by policies and procedures

• No enforcement

Custody of client assets: The OCIE also noted that Advisers did not have policies and procedures limiting the ability of supervised persons to process withdrawals and deposits in client accounts or changing of client address of record. By not having adequate policies and procedures in place some firms unknowingly had custody of client assets and would be required to follow the provisions of the Custody Rule. These included:

• Comingling assets with client assets

• Trustee for client accounts

• General Partner to an advised limited partnership

• Received client checks in branch offices and deposited these checks with the client custodian

• Arrangements allowing for broad disbursement authority over client assets

Fees and expenses: Fees and expenses were also an area identified where Advisers did not have adequate controls in place to identify and remediate instances where undisclosed fees were charged to clients. The OCIE noted that most fee billing issues were related to the lack of oversight over fee billing processes, and in some cases, this resulted in overcharges to clients. These overcharges included:

• Inaccurate fee calculations: misapplying tiered fee structures or incorrect valuations

• Inconsistently applied fee reimbursements: refunds for prorated fees paid in advance

• Charged fees different than the rates included in advisory agreements

Oversight and supervision of supervised persons: Deficiencies related to oversight and supervision of supervised persons included the following items. 

• Failure to disclose material information, including disciplinary events

• Portfolio management, including recommendation of mutual fund share classes that were not in the client’s best interest

• Trading and best execution

It was also noted that the deficiencies were higher for branch office locations with personnel with higher risk profiles.

Advertising: Deficiencies related to advertising were identified as materials prepared by supervised persons located in branch offices as well as supervised persons operating under a DBA. Examples of deficiencies included:

• Performance presentations omitting material disclosures

• Superlatives or unsupported claims

• Professional experience and/or credentials of supervised persons or the firm that were falsely stated

• Third-party rankings or awards that omitted material facts regarding these accolades

Code of ethics: A number of firms were cited for the following deficiencies:

• Complying with reporting requirements, including submitting transactions and holding reports less frequently than required by the rule or not submitting reports at all

• Reviewing transactions and holding reports

• Properly identifying access persons

• Including all required provisions in their code of ethics, including review and approval process prior to a supervised person investing in limited or private offerings, initial and annual holdings report submissions, and quarterly transaction report submissions

Investment Advice

Portfolio Management: More than half of the advisers examined were cited for deficiencies related to portfolio management. These deficiencies included:

• Oversight of investment decisions

• Mutual fund share class selection and disclosure issues

• Wrap fee program issues where advisers failed to adequately asses whether programs were in the best interest of clients, erroneously charging commissions, misrepresented or failed to have appropriate disclosures regarding their program (i.e., fees, trading away practices, and delegation of responsibility), failure to implement appropriate oversight of trading away practices, including monitoring whether sub-advisers traded away. Such practices typically caused clients to incur additional costs.

• Rebalancing issues that for example created short term redemption fees from mutuals funds.

• Disclosure of conflicts of interest

• Certain advisers were cited where conflicts of interest were not fully and fairly disclosed, such as expense allocations that appeared to benefit proprietary fund clients over non-proprietary fund clients or failure to disclose financial incentives for advisers and/or their supervised persons to recommend specific investments.

• Trading allocation decisions

• Advisers were cited for lack of documentation demonstrating the adivers’ analysis regarding obtaining best execution for their clients, completing principal transactions where securities were sold from the firms’ inventory without prior client consent and inadequate monitoring of supervised persons’ trading, including improper allocation of block trade losses to clients rather than to the supervised persons.

Branch Office Observations

The staff provided a number of observations relating branch supervision and meeting the Compliance Rule. Advisor policies and procedures need to address all office locations and all types of relationships (i.e., independent contractor or employee; home office or branch office). Key areas for establishing appropriate procedures included:

• Uniform policies regarding oversigt, monitoring and approval of advertising as it pertains to branch offices utilizing DBA websites

• Centralized, uniform process to manage client fee billing

• Centralized process for monitoring and approving personal trading activities for all supervised persons

• Uniform portfolio management policies and procedures

The staff also noted that Advisors performed compliance testing and reviews of branch locations annually and in certain cases more frequently as needed. During the exams firms reviewed the following types of activities:

• Portfolio management decisions

• Designation of individuals within the branch office[s] to provide portfolio management monitoring

• Consolidate the trading activities occurring within branch offices into the Adviser’s overall testing practices

• Conducting reviews that did not solely rely on self-reporting by personnel

Advisers established policies and procedures relating to prior disciplinary events when hiring supervised persons and establishing periodic reviews of those individuals. Advisers also required compliance training for branch office employees on a semi-annual or at least annual basis.

The key take aways from this alert are to ensure that as a firm you have developed appropriate policies and procedures and to make sure that you are adhering to those policy and procedures. We encourage firms to at least annually complete a review of your existing documents to determine if any changes need to be made within those documents to account for any day to day changes that may have occurred within any particular compliance area.

Click here to read the full alert.

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