On July 23, 2019, the Office of Compliance Inspections and Examinations (“OCIE”) released a Risk Alert (the “Alert”) on the results of examinations of investment advisers focused on compliance, supervision, and conflicts. The Alert described both common deficiencies and best practices found during 50 examinations conducted in 2017 as part of OCIE’s Supervision Initiative. The initial focus of the exams was to review retail firms that employed individuals with disciplinary histories. However, OCIE also reviewed firms overall supervisory systems and how conflicts were identified and mitigated.
Common deficiencies included:
- Inadequate disclosure regarding disciplinary events of the firm or its supervised persons.
- Compliance programs that failed to address risks surrounding the hiring and employing of persons with disciplinary histories.
- Policies and procedures that did not document the responsibilities and expectations for supervised persons, especially in the areas of fees charged, advertising materials, and remote employees.
- Failure to implement policies that specifically named certain individuals to perform certain tasks; thereby causing supervisory failures.
- Adopting written policies and procedures that were in contradiction to actual business practices.
- Annual reviews that were undocumented or failed to identify risks to the firm.
- Special compensation arrangements that were undisclosed, such as forgivable loans to employees or incentivized arrangements.
Best practices observed included:
- Written policies that cover the risks of hiring and employing supervised persons with a disciplinary history.
- Conducting specific due diligence tasks when hiring, to include background checks, social media searches, internet searches, fingerprinting, use of third party vetting agencies, and contacting personal references.
- Reviewing U-5s and IARD/CRD 30 or 90 days post-hire to verify that no new information was added that would be disqualifying.
- Heightened supervision procedures for employees with a disciplinary history.
- Written complaint policy that specifically address complaints against employees and how to escalate those complaints.
- Procedures on the oversight of remote employees and how these employees maintain compliance.
Although the focus of the Supervision Initiative was primarily retail firms, many of the risks identified as areas of concern may also be found in institutional money managers. All advisory firms must have adequate supervisory systems in place. Without proper oversight practices, both retail and institutional clients may be put at risk when conflicts are not disclosed and monitored in such a way as to prevent unfair treatment of clients.
