CCO Series - Client Suitability

As a fiduciary, an RIA firm is required to make investment decisions in the best interests of its clients. When making decisions regarding the investment options for accounts an RIA firm needs to be able to defend such decisions as being reasonably suitable to the goals and needs of its beneficial owners. Regulators will seek to ensure that decisions made by the firm during the course of providing its services primarily benefit the client and are suitable for a particular account's objectives. Documentation that define a fund's investment objectives or a model portfolio strategy will be compared against the trading history and the decisions made for clients to validate whether or not the firm is making suitable investment decisions when providing its services.

RIA Client Suitability In a Nutshell

Client suitability starts with information about how the RIA firm's investment managers will provide its advisory services and the information about the client or fund that will be relied upon to guide those decisions. For a typical retail RIA situation, this may include your client profile, risk tolerance questionnaire, investment policy statement (IPS), or client notes capturing similar information. For structured investment products this may include the operating agreements, offering documents, and similar information about the funds, parties and entities involved. As these documents are executed, modified, updated or amended the advisor should keep and maintain this additional documentation for their firm's books and records.

Risks related to strategies used by an RIA firm must be disclosed to clients through Form ADV. Specifically in Form ADV Part 2A, the Disclosure Brochure, Item 8 Methods of Analysis, Investment Strategies and Risk of Loss should contain information regarding how the firm's investment management services will be applied to the client's accounts and the potential losses that can occur due to the way the firm will invest the client's assets. It is important for firms to review these disclosures and ensure they accurately reflect the firm's investment methods and cover the risks related to the firm's advisory services.

Confirming Suitability

After collecting a client's information, having them sign an advisory agreement and providing a copy of your ADV and other new client paperwork, suitability becomes a compliance matter for the relationship as you move to digest the information and start making investment decisions for the client's account(s). While your documentation may tell the client to notify your firm of any changes to their profile, goals or objectives, every RIA firm still has an obligation to reach out to the client and confirm the information you have is still accurate and that ultimately to confirm your current understanding of what is suitable for that client.

Confirming suitability can take the shape of having the client complete a new risk questionnaire, sign a new IPS, or to have a meeting with the client where you discuss the management of their account and address suitability matters. Documenting this confirmation is critical to the firm's books and records for compliance purposes on this topic, and can take the form of client notes indicating suitability was discussed and the results of that discussion, or the updated formal documents such as the questionnaire or IPS. For fund managers, this activity means ensuring that the decisions being made for the fund are reasonably accomplishing the objectives of the fund as described in its documentation and ensuring that due diligence documentation is retained for various non-public investments. By having this documentation in your firm's books and records you can demonstrate that your firm has upheld their fiduciary duty when making investment decisions for its various clients.

Through the Regulator's Eyes

Regulators expect RIA firms to maintain documentation on each advisory client to support the investment decisions made for their account(s). During an examination, regulators will typically ask firms to provide their risk questionnaires or similar documents used to obtain information about their clients, and will also request information about trades in client accounts, and will reconcile the two to ensure that decisions made for clients are suitable and that there is a rational basis between the documentation, analysis, and investments. Further, regulators will review the information in your firm's disclosure brochure to reconcile to the types of investments to ensure that the strategies and risks are properly and fully disclosed to clients.

CCO Best Practices

Conduct a random sampling review of client files to verify that suitability is appropriately documented. Run a comparison between the client's trading history and the suitability documented to ensure investment decisions are in line with investment objectives. Validate that the last outreach attempt to each client is within one year. Additionally, review your firm’s client intake/onboarding and ongoing review process to ensure you are capturing adequate information to make, or continue to make, appropriate investment decisions in client accounts and provide advice that is in the client’s best interest.

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.

Read More

CCO Series: The Race to Zero Commissions

Wrap Fee Programs

A program that investment advisors once utilized to offer their advisory services for a single combined fee, now has a new wrinkle. As you have heard from us many times, part of an investment advisor’s fiduciary duty is to recommend services that are in the best interest of the client. Given the industry shift to no transaction fees for stocks and ETFs, if you currently offer a wrap fee program to clients where you charge a higher advisory fee to take into account transaction costs, have you asked yourself if wrap fee programs really are in the client’s best interest?

It is our belief that regulators will be asking you this question the next time you are visited. Historically wrap fee programs have been scrutinized by regulators to ensure their appropriateness. Specifically, under the microscope were reverse churning and high cash balances. Zero commission on certain securities will certainly draw the attention of examiners as they determine if a wrap fee program is in a client’s best interest.

Action Item:

If you sponsor or recommend the use of a third party wrap fee program, we strongly urge you to conduct a review of the underlying investments utilized to build client portfolios. Items to consider include:

In the last month, we have seen an old fashion pricing war between brokerage giants across the industry. Things kicked off in late September with Interactive Brokers and the introduction of IBKR Lite, followed by Schwab, TD Ameritrade, ETrade and most recently Fidelity moving to zero commissions on all U.S. stock and exchange-traded fund (“ETF”) trades. The initial news sparked positive reactions from your average investor. Zero commissions for stocks and ETFs, what could possibly be wrong with that?

After the dust has started to settle, it got us thinking about the future of wrap fee programs and custodial partnership due diligence. Below we discuss both elements to get you thinking as well.

The Future of Wrap Fee Programs and Custodial Partnership Due Diligence

CCO Series: The Race to Zero Commissions

What is the composition of underlying investments in the wrap fee program (percentage allocated to stocks, bonds, ETFs, mutual funds, options, etc.)?

Do you primarily invest in individual exchange-traded securities such as stocks and ETFs?

Do you primarily invest in mutual funds and if so, are they generally transaction fees or no transaction fee funds?

As you complete your review you may determine that staying the course with your wrap fee program is appropriate. However, if you determine that after your review a change is necessary you should begin to map out how that change will need to be implemented. You may decide that a wrap fee program is no longer necessary for clients. Or you may decide that the fee you previously were charging is no longer appropriate. Whatever the change is, you are urged to put the plans in place to see through a timely and accurate change.

Custodial Partnership Due Diligence

Whether you have brokerage discretion or recommend custodians to clients, these new incentives should be evaluated when considering your existing institutional relationships with your custodians. Although there is no immediate action needed, it’s certainly something worth staying on top of, as changes continue to unravel forcing increased competition in the brokerage space. It’s unclear where all of this is headed as there is already some speculation about potential changes to custody fees to make up for lost revenue and the layering of additional restrictions on zero commission accounts. Needless to say, it seems as though zero commissions are just the beginning.

We encourage all investment advisors to leverage this opportunity to document these reviews and as you complete your due diligence efforts, remember to document! This documentation can be captured either within AdvisorCloud or your own books and records.

AdvisorCloud

What does AdvisorAssist Recommend?

Please contact us at support@advisorassist.com or through your AdvisorCloud if you have any questions.

support@advisorassist.com

1

1122

Read More

The AdvisorAssist CCO Series: Books & Records

Books and records compliance for registered investment advisers is one of those activities that can be as simple or as difficult as one chooses to make it.

Admittedly, it does take some time and know-how to understand exactly must be maintained. But if you think about it, each of these records are really just outputted from a well-managed firm (e.g. financial statements, communication tracking, version-controlled document storage). By and large, each requirement has a purpose behind it that will help you manage your firm in a more effective and risk-managed manner.

So if you approach records retention not as a compliance requirement but as a result of sound business management, you will be amazed by how it can be simplified, while at the same time improving the effectiveness of how your firm is run.

Investment Advisor Books and Records In a Nutshell

Investment advisors are expected to make and keep true, accurate and current books and records relating to its investment advisory business. The overarching objective behind these requirements is the protection of your clients and the general public. Regulators expect advisors to be able to produce any information that may be used to substantiate their finances, support the decisions behind all of the decisions they make on behalf of their clients, and validate that they are always adhering to their fiduciary duty.

The records that advisors must maintain fall into these general categories: Compliance Program, Client Management, Trading, Marketing, and Business Management. The majority of these must be maintained by all advisors, but there are a number that depends on your specific business practices (e.g. soft dollar usage, proxy voting, custody, government-related clients, use of solicitors).
For reference, here is a link for the complete books and records requirements for investment advisors. Click Here.

Most records have a prescribed retention duration of five years (the most recent two of which must be on-site or accessible from your office). Some records must be retained for longer periods of time, or indefinitely. For example, an advertisement for a one-time event must be kept for 5 years from the date of the event (it's last use) and a Client Agreement (while the client is active) must be kept as long as you have this client under this agreement. And then you must keep for at least 5 more years.

Thankfully, regulators allow for records to be maintained electronically using cloud-based storage. When doing so, advisors must demonstrate their ability to reasonably safeguard them from loss, alteration or destruction and to prevent unauthorized access from individuals outside your firm. Scanning and storing hard copies is fine as well, as long you can attest that the retrieved record is legible, complete and true.

Through the Regulator's Eyes

It's helpful to keep in mind that the purpose of advisor records retention is to protect the general public, including your clients. Regulators expect you to be able to produce any information that may be used to substantiate your finances, support the decisions made on behalf of your clients, and validate that you are always adhering to your fiduciary duty.

Thinking through an example of a client complaint sometimes helps reveal the regulators' logic. Regulators are obliged to respond to every complaint lodged against an advisor. When doing so, they will likely want to see the documentation of everything that client received from you (historical versions of your ADV, marketing collateral), nature of the relationship (client agreement), any interim communications (client communications log), and any supporting documentation for your investment decisions.

A complete set of records will allow you to produce this history quickly and efficiently so that the regulator can come to a swift resolution.

State regulators have stepped up "books and records" examinations, especially with newly-registered advisors. Their objective is to assess not only the ability to produce these records but also the business practices that surround them. If they perceive sloppiness or indifference, they come back for a more complete examination.

CCO Best Practices

• Create an "inventory list" that includes all books and records requirements. Then, mark off those which pertain to your particular business model and practices. For example, your inventory list will include proxy voting records, but if you don't vote proxies, mark it as "NA". This way you are demonstrating that you understand that proxy voting records should be maintained, but since your agreements and ADV state that you don't, this doesn't apply.
• Don't approach records retention as a "compliance chore". The path of least resistance in the long term is to incorporate these responsibilities into your everyday activities. For instance, your client on-boarding process should include each of the activities and documents needed for compliance retention. If you are using your CRM religiously, you can be confident that all client communications are archived in an easily accessible manner as well.
• Be wary of over-reliance on third-party generated records. Your portfolio management system may not store all of the order ticket and confirmation data you need to pass muster with a regulator.
• Remain mindful of regulatory "hot spots". Hot spots include advertising (review and archiving), email/social media archiving, security of electronic storage, and documented investment decision making.
• Pay particular attention to your firm's "high risk" areas. These may include trade allocation procedures, social media advertising, soft dollars, or any area where there is a disclosed conflict of interest.
• Conduct (and document) annual due diligence on cloud storage vendors to ensure that they have appropriate physical, electronic and procedural safeguards in place to secure your data.

Read More

Who's Who in the Eyes of RIA Regulators

Years ago, as a partner in a small advisory firm, I was asked to review and update our compliance program. This firm was a bit more complex than most, in that we had a pretty expansive set of outside shareholders, contractors and advisory board members in place. When I got to the topic of reviewing "roles" of each of these individuals I got a bit stumped. Who exactly were our "access persons"? Supervised persons?

Fortunately in most wealth management business models, determining "who's who" in your advisory firm is fairly simple ..assuming you understand the SEC's definitions of each role.

Here is an overview of each defined role that advisors must identify and monitor.

Chief Compliance Officer (CCO)

This is an individual that is responsible for administering and enforcing your firm’s compliance program. The CCO may delegate responsibilities to appropriate designees as long as he/she remains primarily responsible for compliance oversight and administration.

The CCO must be empowered with full authority to develop and enforce your firm’s compliance policies and procedures. The CCO and designees must be competent and knowledgeable regarding the Investment Advisers Act of 1940 as well as securities laws that apply to your investment process.

Key Takeaways: Be able to demonstrate that your CCO is knowledgeable of securities regulations and has sufficient authority to enforce and affect change.

Investment Adviser Representative (IAR)

Any person that (for compensation) makes any recommendations or delivers advice to clients; manages client portfolios; determines which recommendation or advice regarding securities should be given; solicits, offers, or negotiates for the sale of or sells investment advisory services, or supervises people that perform any of these activities.

Key Takeaways: Essentially anyone that provides (or sells) advice for your firm will be considered an IAR. With the exception of administrative duties (like answering the phone, taking messages, or setting up meetings) everyone that has client contact should be an appropriately-licensed IAR of your firm. This includes solicitors.

Supervised Person

A supervised person is any partner, officer, director (or other person occupying similar status or performing similar functions), or employee of an investment adviser, or another person who provides investment advice on behalf of the investment adviser.  This definition essentially defines those individuals that are considered to be under the supervision and control of your firm.

Key Takeaways: Essentially includes your entire team including external solicitors. Your Written Supervisory Procedures apply to all Supervised Persons.

Access Person

Access Persons are anyone that has access to nonpublic information regarding client transactions or who is involved in making securities recommendations to your clients or has access to recommendations that are non-public.

Key Takeaways: Non-public information includes client information, trading activity, and model portfolios. Access persons are subject to your firm's Code of Ethics and Personal Trading Policies.

CCOs should maintain an up-to-date list of people that fall under each of these categories. By doing so, they will be in a solid position to ensure (and document) that policies are applied to appropriate people that fall under their firm's compliance program.

Read More

Guest Post: 3 Critical Steps to Improve Your RIA's Cybersecurity

Wes Stillman is the chief executive officer of RightSize Solutions, a provider of cybersecurity and technology management services for wealth management firms. We have asked Wes to share a few tips on cybersecurity for RIAs:

Cybersecurity is a growing concern, and recently has become a hot button issue amongst business publications and consumer national news. Regulatory boards that monitor the financial services industry are taking note to quickly shift accountability to financial advisors.

While these may seem daunting at first glance, the better you plan to address these issues the more prepared you will be for an audit, and equally important, how you’ll respond to an unforeseen incident.

To help you manage this critical aspect of your business's health, success and security, as well as clients personal too, here are 3 proactive steps you can immediately take:

“9 out of 10 organizations do not believe their cybersecurity fully meets their needs.” EY Global Information Security Survey

1. Survey your existing technology environment. You can find easy wins, and avoid pitfalls, by just recognizing your strengths and weaknesses.

The best place to start is by looking at what you already have. Take an inventory of what policies, software and hardware your firm utilizes. Where are your weak points? Consider the business partnerships and data exchanges your company executes on a daily basis. In today’s interconnected business environment, our data supply chains create many access points to your customers’ data. Make sure you are doing your part to protect these connections. Understand and document how your partners are protecting your clients’ data. Some partners, like your custodian, may offer tools and assistance for improving your security. As a last line of defense, check your Errors and Omissions Insurance, many policies now include or require cybersecurity. If yours does not, consider a standalone Cyber-insurance policy. Keep in mind, having insurance protection is important, but it does not negate the need for proper processes and procedures in place.

“62% of cyber-breach victims are small to mid-size businesses, which are at the greatest risk for an attack. Their level of preparation is low, and the costs of customer notification alone can be enough to do a small company irreparable financial harm.” PropertyCaualty360

2. Make sure the IT/cybersecurity section of your employee handbook is up-to-date and enforceable

Establish a clear contingency plan for dealing with cybersecurity incidents. Make sure your plan has both preventative and reactive action items. Do you have a clear contingency plan set in place and a process for responding to cyberattacks? Do your employees know what is expected of them? To ensure this, create actionable steps for dealing with employees, clients, partners, members of the press, and police & government. Think about all of the levels of security at your company. Clearly lay out who has access to what and control administrative privileges accordingly (both with internal staff and outsourced vendors). For example, by limiting the ability to install drivers and execute applications can help control what gets onto your systems and prevent attacks like ransomware.

Lastly, recognize the impact of social media and create a policy specific to it. Not only does it distract employees, social media is a direct portal to cyber incidents. RIAs are prime targets for advanced phishing campaigns because much of their personal and business information is available online. Social Media should be monitored for both public and employee comments. Policies should restrict what employees can and/ or should be saying on Social Media accounts. Be sure to include any company social media accounts in your archive process for auditing purposes.

“Elite RIAs are more focused on maximizing their investments in existing technology as well as their partnerships with technology vendors.” InvestmentNews Research and BlackRock Elite RIA Study

3. Empowering your entire company to participate in awareness and rewarding employees when they do, can drastically improve your security

Building a culture of cybersecurity is one of the most important things you can do. Lead by example; regularly discuss cybersecurity in staff meetings and with other internal communication. Employees need to be empowered with knowledge and a shared commitment that goes far beyond the annual ‘check the box’ that you have read and understand the company IT policies. If an incident does occur, let your employees know about it. Not only will it help deter the impact of the incident, it will help your employees develop a team approach to cybersecurity. When employees alert management to mistakes early in the process, they are giving management the opportunity to prevent huge losses of time, data, and money. Specific ways that you can educate employees are by conducting mock cybersecurity drills, scheduling periodic ‘test’ phishing emails or phone calls. Discussions regarding recent and specific documented cases should be had in staff meetings. Question employees directly on how they would individually handle such situations.

In conclusion, the biggest stumbling block for registered investment advisors when it comes to guarding against cybersecurity breaches is not technology-based, it’s a people problem. The right technology is critical, but RIA leaders can face a bigger challenge in fostering a cybersecurity-sensitive culture in a way that resonates throughout all levels of their firms.

Read our ‘Managing Your Company’s Security Policy’ whitepaper for all 10 tips to help improve your firm’s cybersecurity.

Guest Contributor:

Wes Stillman is the chief executive officer of RightSize Solutions, a provider of cybersecurity and technology management services for wealth management firms.

Read More

Wyoming RIAs - Get Ready for Changes!

In March 2016, the State of Wyoming joined the ranks of other states by implementing the Wyoming Uniform Securities Act.

For years, Wyoming has been a sanctuary for registered investment advisors that sought registration with the U.S. Securities and Exchange Commission ("SEC"), but did not have the requisite $100 million in assets under management ("AUM").

In other states [excluding NY], an Advisor with less than $100 million in AUM was required to register with the state securities division of their home state and other states in which the advisor had a place of business or clients exceeding a de minimis level. As Wyoming did not have formalized securities regulations, those advisors became the jurisdiction of the SEC.

With the implementation of Wyoming’s Uniform Securities Act, Wyoming will require registered investment advisors to register with Wyoming state securities division if they have less than $100 million in AUM. The new legislation will take effect on July 1, 2017..

The SEC has begun contacting firms that may be affected by this change. If you are in need of assistance in updating your registration or transitioning from SEC to state registration, please contact us at advisors@advisorassist.com.

---

Sample [redacted] notice from the SEC:

From: IARDLIVE [mailto:IARDLIVE@SEC.GOV]
Sent: 09 February 2017 22:01
To: [Advisor]
Subject: [Advisor - CRD######]

We are contacting you about your status as an SEC registered investment adviser with a principal office or place of business in Wyoming. As you may know, investment advisers with a principal office and place of business in Wyoming have been required to register with the SEC because the State of Wyoming has not previously regulated investment advisers. Advisers indicate this basis for SEC registration by checking the box for Item 2.A.(3) in Form ADV.

The State of Wyoming has recently adopted legislation to begin regulating investment advisers on July 1, 2017. See Wyoming Uniform Securities Act. After that date, SEC registered investment advisers will no longer be eligible for SEC registration solely on the basis of having a principal office and place of business in Wyoming. If you are an adviser with regulatory assets under management of over $100 million or you have another basis requiring you to remain registered with the SEC after the Wyoming legislation goes into effect on July 1, 2017, we encourage you to select the checkbox on Item 2 in Form ADV indicating that other basis for SEC registration as early as possible and uncheck the Item 2.A.(3) box. Additionally, if you are required to remain registered with the SEC after July 1, 2017, you should consider whether you will also be required to include Wyoming as a state in which you must provide a notice filing in Item 2.C.

If you are an adviser that does not have another basis requiring you to remain registered with the SEC after July 1, 2017, you may be required to become registered with the State of Wyoming or other states in which you conduct business. State regulator contact information may be found at the Contact Your Regulator - NASAA webpage. You may apply for state registration by filing a new Form ADV through the IARD system (select the "Apply for registration as an investment adviser with one or more States" option) and file a partial ADV-W withdrawing from SEC registration after your state registration has been approved. Advisers that are no longer eligible for SEC registration after the Wyoming state legislation goes into effect on July 1, 2017 and who have not applied for state registration may be subject to having their SEC registration cancelled.

You may reply to this email if you have questions or contact us at 202-551-6999.

Regards,

INVESTMENT ADVISER REGULATION OFFICE
Division of Investment Management
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549-8549
P: (202) 551-6999
www.SEC.gov

Read More

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

Read More

Don't forget about your annual renewal fees!

We have officially entered the annual renewal season for 2016! As we prepare for the holidays, don't forget that you must submit payment for your firm's annual renewal fees. Failure to do so by the stated deadline will result in the termination of your RIA's registration.  You should have already received an email from FINRA in regards to your Preliminary Statement.  Your preparations should be underway now as the deadline for payments is December 18, 2015.  What do you need to do?  


Complete a thorough review of your current registration status.  Here are a few questions to ask yourself:

• Based on your client growth, have you exceeded the de minimus threshold in additional state(s)?  
• Are you currently registered in any states where you are now under the de minimus threshold?
• Are your IARs properly registered?  Key Reminder: For SEC firms, some states do not require IAR registration if there is no place of business or under the de minimus threshold. 
• Once you have confirmed your applicable registrations, make sure to validate the fees calculated by FINRA and transfer funds into your Renewal Account (IARD system). 

If you are not an AdvisorAssist Compliance Client and are seeking assistance with the Annual Renewal process, please contact us at:  sales@advisorassist.com.

For more information, please see the IARD Renewal Program page:  http://www.iard.com/renewals.asp

Read More

CCO Series (2015) - Financial Statements

The financial statements that you maintain for your RIA firm, which include income statements, balance sheets, statements of cash flows, are powerful tools. Apart from the fact that they are a required to be maintained for books and records purposes, the data that they contain hold the key many other critical regulatory and practice management activities.

RIA Financial Statements In a Nutshell

Maintaining complete and accurate financials on your business simply makes good business sense. However, our primary purpose here is the maintenance of financial statements for compliance purposes, which may include:

• Balance Sheet and Income Statement
• Cash Journals - Documentation including cash receipts and disbursements, records, and any other records of original entry forming the basis of entries in any ledger
• Banking Information - All checkbooks, bank statements, cancelled checks and cash reconciliations for your firm
• Business Expenses - All bills or statements (paid or unpaid) relating to the business of your firm
• Other Financial Statements - All trial balances, financial statements, and internal audit working papers relating to the business of the firm

While maintaining proper financial statements is required in order to avoid regulatory sanctions, it can also be a useful tool for RIAs. Creating and reviewing financial statements on a regular basis can prove to be an indicator of the health of the firm. The financial statements can demonstrate that the firm is performing as intended and disclosed, or act as a tool to show areas where it can improve. Ensuring financial stability of a firm is an important step in gaining client and regulatory confidence. Proving to be solvent and possess secure financials could be the difference between gaining and losing clients, or spending more time with regulators during an exam.

State Specific Requirements

Many of the regulations regarding financial statements for RIAs are dependent on the advisor’s principal state of business. Along with SEC Regulators requiring specific actions regarding financial statements, each state also has specific requirements on the issue. As an advisor it is important to recognize your specific state’s requirements in order to avoid unnecessary regulatory issues. Currently, there are states that require audited financial statements to be sent to their state regulatory agency each year. This applies only if the firm is registered with the state, and does not apply to SEC firms.

It is important to stay updated on your specific state’s requirements in order to avoid unnecessary regulatory issues. Depending on the state, there may be minimum net worth requirements that are to be demonstrated through the financial statements. Where applicable, your firm’s books and records archive should contain the necessary financial statements and audit results.

Custody’s Additional Burdens

When an advisor claims custody of their clients’ assets, there are additional rules and regulations to be aware of in regards to Financial Statements. Advisors that also act as Custodians may be required to submit an audited balance sheet at the end of the their fiscal year. This balance sheet must be prepared in accordance with generally accepted accounting principles (GAAP), and audited by a certified public accountant (CPA). The audit must also include the accountant’s opinion and other qualified notes regarding the firm’s financials. Custodian advisors must also provide clients with a quarterly account statement that outlines all of the activity of their funds in the given period.

Through the Regulator's Eyes

Regulators expect RIA firms to maintain updated financial statements that are created in accordance with generally accepted accounting principles (GAAP). Regulators have put an emphasis on monitoring the financial statements of newly-registered advisors. If they are not completed correctly, it is a sign that a further examination is needed. Compliant financial statements prove to the regulators that the firm is running effectively. Proper maintenance and submission, if required, of updated financial statements is one key way to avoid regulatory sanctions.

CCO Best Practices

• Do not approach financial statements as just a way to avoid regulatory sanctions. They are important at spotting financial irregularities which might benefit you.
• Utilize financial statements as a powerful tool to indicate advisory effectiveness and compliance.
• Always stay informed of specific state requirements, which may differ from SEC and other states’ regulations, for example:
  • Alabama and New York require audited financial statements regardless of custody.
  • If the firm claims custody, the following states require annual audited financial statements: Arizona, Arkansas, California, Washington D.C, Florida, Hawaii, New Mexico and Oregon.
  • Other states may not require financial statements to be submitted at all.
• Maintain accurate financial statements, in accordance with generally accepted accounting principles (GAAP).
• Claiming custody of clients’ assets will require an audit by an independent public accountant registered with, and subject to regular inspection by, the PCAOB.

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

Read More