Risk Alert for Investment Advisers

Published on Sep 7th, 2023 |

Risk Alert for Investment Advisers | SEC Releases

SEC Releases

Brief Introduction

The SEC Division of Examinations (“Division” or “EXAMS”) recently published a Risk Alert to give additional information about the Risk-Based Approach the Division takes for selecting Registered Investment Advisers (“RIAs”) to examine and which risk areas to focus on.

Additionally, the Risk Alert describes what information is typically requested during SEC Examinations.

How the Division selects RIAs to Examine

The Division may be concerned:
- About a Firm’s specific risks due to complaints, material events, tips.
- Due to the history of disclosures and/or reviews of disclosure documents such as Form ADV and Form PF.
- If prior Examinations found significant and repetitive deficiencies in Compliance Programs and Fee/Expense Procedures.
- By Supervisory Issues including multiple disciplinary actions being taken towards associated individuals.
- With business activity by the Firm or personnel that could create conflicts of interest.
- By indicators that the adviser could be vulnerable to market or financial stress.
- From public news or media releases that could involve or impact the Firm.
- If the Firm has access to assets and/or certain gatekeeper or service provider compliance risk.
The SEC also considers its annual priorities and considers which advisers provide services or recommended products that fall under those topics.
- Examinations can help the Division understand how Firms are responding to changes in regulatory requirements.
Firms may be selected based on the length of time since registration or last Examination, or if any material changes have been made in leadership.

Focus Areas Selected During Examinations

The scope of the Examination and documents requested will vary based on the Firm’s business model, risks, and reason for Examination.
Typical areas of review include advisers’:
- Disclosures.
- Operations.
- Conflicts of Interest.
- Compliance Practices.
Core Compliance Practices examined include (but are not limited to):
- Custody and Safekeeping of Client Assets.
- Valuation.
- Portfolio Management.
- Fees and Expenses.
- Brokerage and Best Execution.

Common SEC Request List Items

General information about Business and Investment Activities
- Organizational Information
  - Organizational Structure, Affiliations, and Control Persons.
  - Remote Offices and Branch Locations.
  - Joint Ventures or other businesses (including those with respect to the Firm or any Officer, Director, Portfolio Manager, or Trader).
  - Current and Former Supervised Persons, Officers, and/or Directors.
- Business Operations
  - Committees.
  - Client Advisory Contracts or Agreements.
  - Agreements and arrangements with Third Parties associated with the Management of Client Accounts.
  - Fees and Payments for services rendered.
  - Power of Attorney obtained from clients.
  - Service Providers and the services they perform.
- Disclosures Documents and Filings with Regulators
- Legal and Disciplinary
  - Threatened, pending, and settled Litigation, Arbitration, or Administrative Proceeding involving the adviser or any supervised person.
  - Remedial Actions taken against supervised persons.
- Compliance risks the adviser has identified and the written Policies and Procedures to mitigate these risks.
  - Compliance Oversight Process
    - Compliance Policies and Procedures in effect during the Examination period.
    - Tests Performed, such as:
      - Compliance Reviews.
      - Quality Control Analyses.
      - Surveillance.
      - Forensic or Transactional Tests performed by the Firm.
    - Compliance Consultant Reports resulting from a review of Compliance Policies and Procedures, Operations, or Books and Records.
    - Annual and/or Interim Reviews of Policies and Procedures, including any reports prepared.
    - Record of Compliance Exceptions.
    - Remote Office and/or Independent Advisory Contractor Oversight Process.
    - Client Complaints and correspondence and the process for monitoring such communications, including Electronic Communication.
    - Inventory of Compliance risks and Conflicts of Interest that forms the basis for Policies and Procedures and notations regarding changes made to the inventory.
    - Written Guidance and Training provided to employees regarding Compliance Program and documentation of attendance.
  - Valuation
    - Valuation Process.
    - Pricing Services, Quotation Services, and Externally Acquired Portfolio Accounting Systems.
    - Used in the Valuation Process and Payment Information.
    - Fair-Valued and Illiquid Securities held by clients.
    - Advisory Fee Calculations.
    - Pricing Overrides.
  - Information Processing, Reporting, and Protection
    - Safeguards for the Protection of Customer Records and Information.
    - Electronic Access Controls.
    - Business Continuity Plan.
    - Cybersecurity Incidents or Breaches.
  - Information to Facilitate Testing of Advisory Trading Activities
    - Advisory Clients and Accounts
      - Current Advisory Client Account Information regarding:
        Account Inception, Type, Balance, and Management Discretion.
        Client Demographic Information.
        Client Affiliation with the Firm.
        Custodial Arrangements.
        Firm Authority with respect to the account (e.g., Trading Authority, Custody, and Trustee).
        Services Provided.
        Investment Strategy and Investment Objectives.
        Portfolio Manager.
        Fee Computation.
        Fee Payment Arrangements.
        Consultant related to obtaining the client, if any.
      - Advisory clients lost during review period.
    - Portfolio Management
      - Securities held in all Client Portfolios, including information identifying:
        Each Client Holding an Interest;
        The amount owned by each client;
        The aggregate number of shares or principal; and/or
        Notional amount held and total market value of the position.
      - Information about certain types of Client Investments (e.g., Private Investments and Initial Public Offerings).
      - Publicly Traded Companies for which employees of the adviser or its affiliates serve as Officers and/or Directors.
      - Companies for which employees of the adviser or its affiliates serve on Creditors’ Committees.
      - Outside Compensation to supervised persons including compensation related to Client’s Transactions or Investments.
      - Client Portfolio Profile Information (e.g., Investment Objectives, Investment Strategy, Risk Tolerance, Suitability, and Mandates).
    - Brokerage and Trading
      - Trade Blotter.
      - Brokerage Arrangements and Best Execution Evaluation Documentation.
      - Soft Dollar Budget and Products and Services obtained using Clients’ Brokerage Commissions.
      - Commission-Sharing Arrangements.
      - Affiliated Broker-Dealers.
      - Principal Trades and Cross Transactions.
      - Wrap Fee Programs.
      - Trade Errors and related information.
      - Trade Allocation information regarding Initial Public Offerings and Secondary Offerings in which clients, proprietary accounts or access persons participated.
    - Conflicts of Interest and Insider Trading
      - Code of Ethics and Insider Trading Policies and Procedures for the Firm and its affiliates.
      - Code of Ethics Attestations.
      - Exemptions from Code of Ethics for supervised persons.
      - Reports of Securities Transactions reported by access persons.
      - Fee Splitting or Revenue Sharing Arrangements.
    - Information for the SEC to Perform Compliance Testing in Other Areas
      - Marketing and Advertising
        Advertisements and Marketing Materials disseminated, including Newsletters, Public Audio and Video Programs, Pitch Books, Pamphlets, Brochures, Websites, Blogs, Social Media, and other Promotional and/or Marketing Materials used.
        Client or Investor Meeting Materials and Presentations.
        Sponsored and attended Seminars or Events.
        Client Performance Information.
        Composite Performance Information, including current and terminated Composites and Composite Returns.
        Requests for Proposal, Due Diligence Questionnaires, and any other Questionnaire (e.g., Third Party Consultant Database or other Performance Database).
        Testimonials and Endorsements, including payments made and compensation received.
        Third-Party Ratings and Rankings.
      - Financial Records
        Balance Sheet, Trial Balance, Income Statement, and Cash Flow Statements.
        Cash Receipts and Disbursements Journal.
        General Ledger and Chart of Accounts.
        Loans and Sales of Firm or Affiliate’s Stock.
      - Custody
        Custodian Identification and Contact Information for entities that maintain Custody of Client Assets.
        Surprise Examination Documentation, such as Engagement Letters, Client Account Lists, and Reports, Results, and Recommendations.
        Auditor Engagement Letters, Opinions, and Findings.
        Custodial Confirmation of Positions for specific clients.

Vigilant's Conclusion

Vigilant’s Conclusion

This is a highly detailed Risk Alert providing a significant amount of useful information for RIAs.

As displayed in the Risk Alert, there is a large amount of information requested during SEC Examinations, and being prepared for them is essential for the kind of compliance success required for business success.

If Firms are either recently registered with the SEC or is has been some time since the last SEC Examination, then we strongly encourage them to consider a Gap Analysis or Mock SEC Exam to determine their preparedness when the SEC comes knocking.