A new Risk Alert (“the Alert”) focused on newly-registered SEC investment advisers has been issued by the Division of Examinations (“EXAMS”). This second Risk Alert of 2023 discusses Staff findings from examinations conducted on newly-registered advisers. The term “newly-registered adviser” is not defined by the SEC but is generally believed to be an entity registered as an adviser with the SEC for no more than one year. EXAMs stated that it uses these examinations to conduct its preliminary risk assessment of the firm, which FrontLine Compliance has found is then relied upon to determine the frequency of any future exams. The risk assessment considers conflicts of interest, firm disclosures, and the nature of the compliance program itself.
FrontLine Compliance has seen many of these new adviser document requests over the years, and they are typically short with just 26 questions and focus on the following topics:
- General Business Information – org charts, personnel info, ownership data, financial information, and legal information on the firm and its advisory personnel
- Client Account Data – types of accounts offered, investment strategy data, client types, use of discretion, supervisory information, AUM data and service provider data
- Compliance Program and Internal Controls – written policies and procedures, including Code of Ethics
- Compliance Testing – Staff reviews of portfolio management and trading, client specific data and holdings
- Marketing – advertising materials, social media usage, websites, blogs, and forms of communications to solicit new or existing clients
Common deficiencies found by EXAMs during new adviser examinations that are discussed within the Alert are:
- Inadequate written compliance policies and procedures
- Lack of or misleading disclosure documents and regulatory filings
- Marketing materials and practices that do not comply with the Marketing Rule [1]
- Annual Compliance Reviews that did not meet the Rule 206(4)-7 requirements
The Staff made a point to state that “off-the-shelf” compliance manuals not properly customized to firm operations or activities do not meet the Annual Review rule requirements. Conflicts of interest posed by personnel wearing multiple hats without proper remediation and disclosures could lead to a lapse in a firm’s fiduciary duty to clients. In addition, EXAMs found firms that outsourced multiple business functions (including compliance) need to have adequate oversight and ensure these responsibilities are consistent with their stated policies and procedures.
Also, the Staff took issue with firms that had inadequate or misleading disclosures to clients on fee billing practices, compensation, conflicts of interest, affiliated relationships, AUM, use of models, aggregated trading practices, disciplinary information, and the use of websites and social media.
The SEC’s New Marketing Rule was NOT a focus area in the Alert, but the Staff still found marketing violations such as inaccurate information on advisory personnel credentials, use of third-party rankings, performance data, and lack of substantiation of claims made in marketing materials.
The Alert does include a few helpful additional resources within a table format for newly registered advisers to keep on hand.
Advisers registered for less than one year, and ERAs or other firms seeking full SEC registration status, should heed the Alert’s findings and ensure the aforementioned compliance areas discussed are adequately addressed.
[1] The Staff stated that the examinations conducted pre-dated the New Marketing Rule.
View Risk Alert, “Observations from Examinations of Newly-Registered Advisers,” March 27, 2023
