Newly Registered Investment Advisors Tread Carefully: SEC Issues Risk Alert

The purpose of these examinations is not to bring enforcement actions. Instead, the SEC describes the examinations as an “opportunity for early engagement between advisers and the staff,” acknowledging that “investment advisers that have recently registered with the SEC … may face unique compliance and risk issues.” An unspoken purpose of these examinations, however, is to identify trends in compliance failure among newly registered advisors and alert advisors about the SEC’s future enforcement priorities.

Examination Purpose and Scope

During an examination, SEC staff conduct preliminary risk assessments and analyze an advisor’s compliance program. Specifically, the SEC examines advisors to determine whether the firms have “(1) identified and addressed conflicts of interest; (2) provided clients with full and fair disclosure such that clients can provide informed consent; and (3) adopted effective compliance programs.

During an examination, the Division reviews an advisor’s documents and interviews advisory personnel. These document requests and interviews address the advisor’s “(1) business and investment activities; (2) organizational affiliations; (3) compliance policies and procedures; and (4) disclosures to clients.”

Among other things, the SEC typically requests and reviews “general information to provide the staff with an understanding of the adviser’s business and operations”; “demographic and other specific data regarding each advisory client account”; “information regarding the adviser’s compliance program, risk management practices and framework, and internal controls”; “information to facilitate the staff testing for regulatory compliance in certain areas, including portfolio management and trading activities”; and “communication used by the adviser to inform or solicit new and existing clients.”

SEC Observations From Recent Newly Registered Advisor Examinations

In recent examinations of newly registered advisors, the SEC noted compliance issues in three primary areas: compliance policies and procedures, disclosure documents and filings, and marketing.

1. Compliance Policies and Procedures. The SEC noted that some newly registered advisors had policies and procedures that “(1) did not adequately address certain risk areas applicable to the firm, such as portfolio management and fee billing; (2) omitted procedures to enforce stated policies … and/or (3) were not followed by advisory personnel.” Additionally, the SEC noted that some advisors’ annual compliance reviews “did not address the adequacy of the advisers’ policies and procedures and the effectiveness of their implementation.”
2. Disclosure Documents and Filings. The SEC noted that some advisors’ required disclosure documents “contained omissions or inaccurate information and untimely filings.”
3. Marketing. The SEC noted that some advisors’ marketing materials “appeared to contain false or misleading information, including inaccurate information about advisory personnel professional experience or credentials, third-party rankings, and performance” and that “[a]dvisers were also unable to substantiate certain factual claims.”

The SEC also reminded newly registered advisors to review the Commission’s previously published Division Risk Alerts, which “contain information regarding common examination observations that are broadly applicable to SEC-registered advisers, including newly-registered advisers.”

Conclusion

While the SEC does not use these examinations of newly registered advisors to bring enforcement proceedings, it is important for newly registered advisors to bring their firms into SEC compliance as soon as possible, whether their firm has been examined or not. This alert telegraphs the SEC’s future enforcement priorities.

ArentFox Schiff attorneys have deep experience advising clients on SEC compliance. Please reach out to Jon Jurva and Gwen Lemley Laurich about how we can help.