SEC Offers Comprehensive Supervision and Compliance Guidance for Investment Advisers

November 16, 2020
by Andrew J. Melnick, Katherine M. McGrail

On November 9, 2020, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations ("OCIE") released a set of staff observations cataloguing OCIE’s assessments of industry practices concerning investment advisers with branch offices geographically dispersed from the firm’s principal office. The observations are notable for their comprehensiveness. The observations discuss common deficiencies identified by OCIE staff in the areas of compliance, supervision, and investment advice.  The staff also offers guidance for firms to meet their legal obligations, including, among other things, highlighting the import of the consistent application of policies and procedures across all offices.  Firms would be wise to consider the deficiencies and guidance issued by OCIE as a tool to develop their own benchmarks for compliance, supervision, and investment advice.

COMPLIANCE AND SUPERVISION.  The staff focused on investment advisers’ supervisory and compliance programs in both their main offices and branch offices.  In particular, the staff reviewed firms’ practices for the Compliance Rule, the Code of Ethics Rule, the Custody Rule, and consistency with fiduciary obligations. Areas of concern include:  

Custody of client assets. A number of advisers did not have policies and procedures that "limited the ability of supervised persons to process withdrawals and deposits in client accounts" and make other changes.  Furthermore, advisers had custody of client assets for a variety of reasons, and that, in turn, resulted in disparate approaches to dealing with the assets.

Fees and expenses. Advisers did not have policies and procedures that covered remediation for overcharges and firms had policies for wrap fees that were not consistently applied.

Supervision. Advisers failed to disclose material information, including disciplinary events of supervised persons, and failed to supervise issues related to portfolio management, such as recommendations regarding mutual fund shares, and trading and best execution.

Advertising. Branch offices operating under a different name from the primary office, a so-called "doing business as" or DBA, had deficiencies related to advertising.  Issues arose with respect to performance presentations that omitted material information, unsupported claims, credentials that were not accurate, and third-party rankings or awards that neglected to include all material information.

Code of Ethics. The deficiencies generally were tied to reporting requirements and review procedures for transactions involving supervised persons and the failure to properly identify access persons.

INVESTMENT ADVICE.  The staff evaluated the processes by which firms provided investment advice to clients, including the oversight of investment recommendations, both within specific branch offices and across all of the advisers’ branch offices, management and disclosure of conflicts of interest, and allocation of investment opportunities.  Areas of concern highlighted by the staff include:  

Mutual fund share selection and disclosure. Advisers failed to disclose that certain mutual fund shares pay 12b-1 fees.

Wrap fees. Questions arose regarding the appropriateness of the wrap fee for particular clients, compliance with the terms of the wrap fee arrangement, and the failure of the firm to supervise transactions.

Rebalancing. Issues were identified pertaining to the automated rebalancing of portfolios and whether the arrangement, which could generate short-term redemption fees from mutual funds, was in fact in the best interest of the client.

Conflicts of interest.  Advisers were cited for failure to adequately disclose expense allocations that appeared to benefit proprietary fund clients over non-proprietary fund clients and financial incentives for the advisers and/or their supervised persons to recommend specific investments.

Trading.  Advisers were cited for a lack of documentation supporting best execution for clients, completing principal transactions involving securities sold from inventory without client consent, and inadequate monitoring of supervised person trading.

GUIDANCE FOR INVESTMENT ADVISERS.  The staff identified a range of practices with respect to branch office activities that firms may find helpful in their compliance oversight efforts. Examples include:

  • Ensure uniform policies and procedures regarding main office oversight for monitoring and approving advertising.
  • Centralize and unify processes to manage client fee billing.
  • Centralize processes for monitoring and approving personal trading activities for all supervised persons located in all office locations.
  • Ensure uniform portfolio management policies and procedures, portfolio management systems, or both, across all office locations.
  • Validate that branch offices undertook compliance or supervision reviews of their portfolio management decisions.
  • Designate individuals within branch offices to provide portfolio management monitoring.
  • Consolidate the trading activities occurring within branch offices into the advisers’ overall testing practices.
  • Conduct compliance reviews that do not solely rely on self-reporting by personnel.
  • Establish compliance policies and procedures to check for prior disciplinary events when hiring supervised persons and periodically confirm the accuracy of disclosure regarding such information.
  • Require customized compliance training for branch office employees.

OCIE’s comprehensive observations and guidance in its recent release signal the SEC’s intense regulatory focus on investment advisers.  In light of it, investment advisers would be well served to consider amending disclosures, revising compliance policies and procedures, and changing certain practices.  In addition, we would encourage advisers, when designing and implementing their compliance and supervision frameworks, to consider the unique risks and challenges presented when employing a business model that includes numerous branch offices and business operations that are geographically dispersed, to adopt policies and procedures to address those risks and challenges, and to apply them consistently across all offices.

Murphy & McGonigle represents SEC-registered advisers and their investment adviser representatives in civil litigation, enforcement, and regulatory matters and advises them on compliance with industry standards and regulatory requirements. The firm’s team includes a number of attorneys who have served in senior positions with the SEC, FINRA, CFTC and federal and state prosecutors, and leading financial institutions.