CCO Series: Top Regulatory Deficiencies for RIAs -- Advisory Agreements

What you need to know

Examiners will review agreements that the advisor uses for its client engagements during an examination as a standard request item. This will include a review of the agreement templates that you use for your prospective clients and a sample of agreements that your firm has executed with existing clients. In reviewing agreements examiners report finding two common deficiencies: 1) the fees are not fully disclosed in the agreement and 2) that firms do not have an executed copy of its client agreements in the advisor’s books and records.

Common Deficiency: Fees fully disclosed

The written advisory agreement must detail the relationship that the client is entering into with the advisor, including how fees are calculated and the payment methodology. The fees section of the agreement must be comprehensive to cover all fees being charged for the services, when the fees are being charged, and how they are to be paid. The information in the client agreement should also align with the general disclosure of fees made in Form ADV Part 2A Disclosure Brochure in Item 5. Any additional compensation that the firm receives in its advisory practice should also be described in Form ADV Part 2A in Item 14.

Common Deficiency: Books and records

Advisors are required to keep and maintain all written agreements (or copies thereof) entered into by the advisor with any client.¹Examiners are reporting to the North American Securities Administrators Association that advisors are not creating written agreements for all of their client relationships. They also noted that when written agreements are created, the agreements are not clearly noting, and adequately explaining, the advisory fees as described above.²

How do we avoid these deficiencies?

To avoid these deficiencies at your firm AdvisorAssist recommends the best practices of:

• Reviewing the language in your Form ADV Part 2A Disclosure Brochure to ensure that it adequately discloses for each type of fee the following:
1. How fees accrue for each service offered.
2. How fees are billed to the clients.
3. Whether the advisory fees include other fees, such as brokerage trading fees.
4. How fees are impacted by contract termination, such as a pro-rata refund if collected in advance.
5. Whether the fees represent any compensation for the sales of securities or other conflicts of interest.
• For each new client onboarded, ensure that a written agreement is executed for the services that the client will receive and the fee is consistent with Form ADV Part 2A.
• Review client agreement[s] templates and Form ADV Part 2A at least annually to ensure that the fees described are consistent and fully disclosed.

<sup>1. See 17 CFR §275.204-2(a)(10). Link. ↩
2. See North American Securities Administrators Association, “2015 Investment Adviser Coordinated Exams,”. Link. ↩</sup>

AdvisorAssist’s CCO Series: Regulatory Deficiencies for RIAs is a series of articles that will help your firm understand and avoid the most common compliance deficiencies found by regulators. Our goal is to help you increase your confidence that your firm remains “exam ready” as well as some practical steps to help Chief Compliance Officers address this topic.

Contributors:
Brendan Furey
Michael Conlon

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CCO Series (2015) - Voting Client Proxies

The right to cast votes on certain corporate matters is an important power given to shareholders of publicly traded companies and mutual funds. Your RIA firm is expected to address its role with respect to voting proxies on behalf of clients. You may agree to take on the responsibility to vote proxies on securities they own, or you may elect to not vote their proxies. In each instance, regulators expect you to have clearly defined and communicated policies and procedures related to this vital aspect of corporate governance so clients understand if and how their votes are cast.

Advisor Proxy Voting In a Nutshell

Shareholders of publicly traded companies and mutual funds have the right to express their opinion on certain business matters that impact the value of the securities they own. Board of director elections, mergers and acquisitions and changes in fee schedules (in the case of mutual funds) are examples of decisions that are delegated to shareholders.

Since most shareholders do not attend annual meetings in person, their opinions on these matters are communicated by casting a ballot either electronically or via mail.

Custodians and broker-dealers normally receive and transmit notices of upcoming proxy votes, meeting and record dates and other information on upcoming corporate actions by companies in which their client’s are shareholders.

Accepting this responsibility for your clients is a significant undertaking, so it is important to consider the pros/cons of doing so. On one hand, clients may appreciate that you serve as their voice in significant matters that affect the value of their investments. But agreeing to vote client proxies requires a significant amount of process monitoring and record keeping.

For this reason, most RIA firms elect to not vote proxies.

Your firm’s policies on voting proxies should be disclosed and clearly described in:

• Form ADV Part 2A, Item 17 - Voting Client Securities
• Advisory Agreements, either in the section that describes your investment discretion authority or in a standalone section

Note: If you have discretionary investment authority over client accounts and your ADV and agreements remain silent on this topic, it is assumed that you do vote proxies.

If your firm does not vote proxies

If your firm does not intend to vote proxies, and you do not intend to advise clients on how to vote proxies, you must disclose this in Form ADV and communicate to clients that they retain the authority and responsibility for voting their own proxies.

If a client reaches out with questions regarding a particular proxy vote, you may assist them in understanding the background and intent of the proxy, but your guidance must not influence their voting decision. In doing so, your firm should remind them that they assume the responsibility for ultimately making the voting decision of making the contractual decision of their voting shares, and that you are prohibited from providing the service of that advice.

In this instance, your clients will receive proxy statements directly from the Custodian. They should not be sent to you.

If your firm does vote proxies

If you do intend to vote proxies, you are required to do so in the best interest of your clients. When setting up new client accounts at your custodian, you should request that they forward proxy statements to you directly instead of your client.

In addition, you must:

• Develop and implement policies and procedures that are reasonably designed to ensure that your firm votes proxies in the best interest of its clients,
• Describe your firm’s proxy voting policy to clients (via Form ADV 2A and advisory agreements) and provide copies to clients upon request, and
• Disclose how clients can obtain information on how your firm voted their proxies.

In fact, regulators consider it fraudulent for advisors to exercise proxy voting authority without fulfilling these three requirements.

Through the Regulator's Eyes

When it comes to proxy voting, regulators simply expect that you clearly communicate your policy on voting proxies for your clients. When you do accept this responsibility, you are expected to exercise this duty in the client's best interest, avoid and disclose any conflicts of interest that may come up in these corporate matters and maintain proper books and records that demonstrate that you are fulfilling this duty in accordance with the Advisers Act.

A copy of the SEC’s final rule on advisors voting proxies can be found here.

CCO Best Practices

• Consider whether or not your clients would gain a material benefit by your advising their proxy voting responsibilities, and if that benefit would be worth the related compliance burden.
• If your firm does not vote client proxies:
  • Review client activities to ensure that your firm has not voted proxies for any clients.
  • Review any exceptions made to the proxy voting policy and all supporting documentation and ensure that all were properly documented and approved by the CCO.
  • If you ever choose to begin voting proxies, revise your proxy voting policy to comply with the Adviser's Act.
• If your firm does vote client proxies:
  • Confirm that existing proxy voting policies and procedures are adequately designed to ensure that votes are consistent with client interests.
  • Conduct a forensic test by reviewing a sample of proxies voted during a particular period and confirm that each proxy was voted in accordance with your policy and that each were voted in the best interest of the client.
  • Review any exceptions made to the proxy voting policy and all supporting documentation.
  • Ensure that all exceptions were properly documented and approved by your firm’s CCO.
  • Review your firm’s books and records to confirm that for the previous five years you can produce a copy of each proxy you received, records for all proxies voted (with any related back up), a log of any proxy voting information requests by clients and your firm’s responses to those requests.

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.

Michael Conlon

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The AdvisorAssist CCO Series: Regulatory Filings (Form ADV Parts 1 and 2, U4)

If the sign on the front of your office got damaged or worn out, you'd replace it, right?

Think of your ADVs (both Part 1 and Parts 2A-2B) and Form U4 as the most visible aspects of your RIA firm. Prospects, clients, competitors, vendors and regulators can (and do) look at it whenever they want. Each of these audiences have different motivations for looking at these filings but they have one thing in common: they will come away with an opinion of your firm.

Beyond being a regulatory requirement, well-drafted and maintained public filings are the easiest way for you to make a good impression on anyone that has an interest in your advisory firm. Over the years we have seen countless ADVs that scream "I found the cheapest person I could find to write this." or "I bought a template off the internet because this is all boilerplate anyway." Regulators will eventually notify you of their opinion of your regulatory filings during an examination. In the interim, there will be countless first impressions that will be made.

And most people won't tell you if your sign's worn out.

Form ADV and Form U4 In a Nutshell

Investment advisors are responsible for ensuring that their Form ADV Parts 1 and 2 are up-to-date and reflective of their current business model. In any given year, data points like regulatory assets under management and the number of advisory clients/accounts must be updated. Likely, the types of clients that you serve and the states where they reside will also require updating. In addition, advisors should ensure they are updating their ADVs for changes in securities laws or regulatory hot points as well.

Any material changes in your business throughout the year will require an immediate update, as well as client notification of the material changes. Materiality is not specifically defined by the regulators, but here's a good rule of thumb: if something changes in your firm that an informed client would expect to be notified of, then it's material.

Form U4s for each of your Investment Advisor Representatives ("IARs") must also be kept up-to-date. Examples of U4 updates include: ensuring that licensing is maintained and up-to-date, confirming that your IARs are properly registered in all states where they perform advisory functions, adding outside business activities, and updating for any disclosure events that may occur.

In the age of social media, it is also imperative that the U4s are accurate and consistent with any other published information about your IARs. For instance, if there is inconsistency between a U4 and a LinkedIn profile, did you post a false advertisement or did you file a false regulatory document?

Through the Regulator's Eyes

Regulators expect that your ADV will always reflect up-to-date and comprehensive information that your clients and prospects deserve to know about your RIA. Clients and prospects should be able to see a comprehensive description of the fiduciary role that you fulfill, as well as all business practices and conflicts of interest that may impact your ability to serve as their fiduciary.

They also expect to see evidence that you have delivered your ADV to all clients (annually) and prospects (prior to executing advisory agreement). Remember, regulators must take a stance that "if it's not documented, it didn't happen."

Regulators also want to see past versions of your ADV so that they are able to reconstruct exactly what was delivered to whom at any given point in time.

CCO Best Practices

• If you utilized a "template" to create your ADV or if you hired a firm that follows a "one size fits all" approach, review your ADV to ensure that it reflects your business, including disclosures for conflicts of interest, outside business activities, advisory services, and advisory fee practices. These are all hot buttons that are often poorly captured in "out of the box" ADVs.
• Update Form ADV Parts 1 and 2 at least annually, within 90 days following your fiscal year end. Update your ADV more frequently for any "material" changes in your RIA.  (Materiality is not defined by the SEC but a knowledgeable compliance professional.
• Deliver your Form ADV Part 2 (or a summary of material changes since the previous delivery) to all clients within 120 days following your fiscal year end. Electronic delivery will suffice.
• Consider including your Privacy Policy at the end of same as the ADV2 ("Disclosure Brochure") document to simplify the document delivery requirements. Your Privacy Policy must be delivered at/prior to client engagement and annually. One less document to worry about.
• Maintain records that demonstrate delivery of Form ADV to clients (annually) and prospective clients (prior to executing advisory agreement)
• Maintain copies of prior versions of your Form ADV Part 1 and 2
• If you take on clients throughout the year that require registration or notice filing in any new states, this should be completed prior to on-boarding these clients. Otherwise, updating the states listed on your ADV 1 through your annual amendment is sufficient.

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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.

Brian Lauzon

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ADV Amendment Filed – What’s Next?

Here are some next steps now that you’ve filed your annual amendment. Below are questions our consultants at AdvisorAssist are frequently asked:

What am I required to provide to Clients?

There are two different routes advisors can take when it comes to delivering their ADV Part 2. First and foremost, regardless of the path you chose for your ADV Part 2, you must deliver a copy of your privacy policy annually. For the ADV Part 2:

• Option 1: If there have been material changes to your business the material changes must be described in ADV Part 2, Item 2. Under the current rules, you could provide your clients with a summary of these material changes and an offer to deliver the entire ADV Part 2. In your offer you must include instructions on how clients can obtain a copy from you.
• Option 2: Advisors can also opt to deliver a full copy of the entire ADV Part 2. In this instance Item 2 - Material Changes still needs to be updated.

Generally, AdvisorAssist recommends that advisors include a cover letter explaining what is being provided to clients and why. For an example letter, please contact us.

May I email this information to Clients?

You may attach the information described above as pdf files in an email to clients. Sending an email with a link to the documents does not constitute delivery. You should only email this information to clients if you generally use email as a means of communication with that client.

When must I deliver the information?

The information described above must be delivered within 120 days of your fiscal year end. Generally the 120 day mark is May 1st, however, since 2012 is a Leap Year, the 120th day is actually April 30th.

What constitutes a material change?

The best way to determine if a change is material is to consult an independent resource who can assist you in making an objective determination. Material changes to your Form ADV Part 2A may include changes to your services, fees, advisory personnel, financial industry affiliations, disciplinary events and financial challenges of the firm or principals, such as a bankruptcy.

Besides my annual amendment, what other times must I update my ADV Part 2?

Investment advisors are required to update their Form ADV Part 2A promptly when the information in the brochure is materially inaccurate. Remember to file your updated Form ADV Part 2A on the IARD system.

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Reminder - ADV 2 Delivery Deadline is May 1st.

Reminder to RIAs - May 1st is the deadline for "Delivery" of your new ADV Part 2A. 


For RIAs with a fiscal year end of December 31st, the filing deadline for your new plain English ADV2 was March 31st, 2011. The next step is to deliver the ADV2 (your "Disclosure Brochure") to your existing clients. The delivery deadline is May 1, 2011, which is fast approaching!


What is meant by "Delivery"?
Delivery of your Disclosure Brochure can be accomplished in several ways, but it must be a push of the actual Disclosure Brochure in a manner that that client will receive the document. In contrast to an offer where you inform the client as to how they might obtain the Disclosure Brochure.

• Email - if you currently communication with your clients via email, you can email as an attachment (in in-line in the message if you can make it work). For the attachment, be sure to use a universal format, like a PDF file. YOU CANNOT sent a link to the client bringing them back to your website or the Investment adviser public disclosure website. That is just an "offer". Your email saved in your archives will serve as your proof of delivery.
• Mail - of course you can always mail your document, but at an average of 15+ pages for the ADV 2A and 3 pages for each ADV2B, that is a less than appealing option for Advisors. And the clients probably don't want the paper! Of course you may have some clients that don't user email, so this is you only option. You will want to maintain proof of delivery, such as the postal receipt and a list of mail recipients with the date mailed.
• Hand Delivery - you can certainly hand deliver the Disclosure Brochure. Be sure to track the activity in your CRM system. If you don't have a CRM, you may want to consider an ADV Delivery log that you keep with the date and time of delivery to each client.

If you would like a sample client letter to accompany your Brochure Delivery, please email us at Advisors@AdvisorAssist.com.

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